Skip to main content

Full text of "Economic impact of alternative fiscal policies: a study"

See other formats


: \ -? W5"/ r 



9 ^d SessSn 88 ^ JOINT COMMITTEE PRINT 



STUDIES IN FISCAL POLICY 



Paper No. 1 

THE ECONOMIC IMPACT OF ALTERNATIVE 
FISCAL POLICIES 



A STUDY 

PREPARED FOR THE USE OF THE 

SUBCOMMITTEE ON FISCAL POLICY 

OF THE 

JOINT ECONOMIC COMMITTEE 
CONGRESS OF THE UNITED^T&TES 

|s-Sep i97e;|[ 




V%> ^'ii' 



AUGUST 16, 1976 



Printed for the use of the Joint Economic Committee 



U.S. GOVERNMENT PRINTING OFFICE 
73-600 WASHINGTON : 1976 



JOINT ECONOMIC COMMITTEE 



(Created pursuant to sec. 5(a) of Public Law 304, 79th Cong.) 

HUBERT H. HUMPHREY, Minnesota, Chairman 
RICHARD BOLLING. Missouri, Vice Chairman 



SENATE 
JOHN SPA RKMAN, Alabama 
WILLIAM PROXMIRE, Wisconsin 
ABRAHAM RIBICOFF, Connecticut 
LLOYD M. BENTSEN, Jr., Texas 
EDWARD M. KENNEDY, Massachusetts 
JACOB K. JAVITS, New York 
CHARLES H. PERCY, Illinois 
ROBERT TAFT, Jr., Ohio 
PAUL J. FANNIN, Arizona 



HOUSE OF REPRESENTATIVES 
HENRY S. REUSS, Wisconsin 
WILLIAM S. MOORHEAD, Pennsylvania 
LEE H. HAMILTON, Indiana 
GILLIS W. LONG, Louisiana 
OTIS G. PIKE, New York 
CLARENCE J. BROWN, Ohio 
GARRY BROWN, Michigan 
MARGARET M. HECKLER, Massachusetts 
JOHN H. ROUSSELOT, California 



William R. Buechner 
G. Thomas Cator 
William A. Cox 
Luct A. Falcone 



Charles H. Bradford 



John R. Stark, Executive Director 
Richard F. Kaufman, General Counsel 

Economists 
Robert D. Hamrin 
Sarah Jackson 
John R. Karlik 
L. Douglas Lee 

Minority 
George D. Krumbhaar, Jr. 



Philip McMartin 
Ralph L. Schlosstein 
Courtenay M. Slater 
George R. Tyler 



M. Catherine Miller 



Subcommittee on Fiscal Policy 
RICHARD BOLLING, Missouri, Chairman 



HOUSE OF REPRESENTATIVES 
WILLIAM 8. MOORHEAD, Pennsylvania 
GILLIS W. LONG, Louisiana 
LEE H. HAMILTON, Indiana 
CLARENCE J. BROWN, Ohio 
JOHN H. ROUSSELOT, California 



SENATE 
WILLIAM PROXMIRE, Wisconsin 
LLOYD M. BENTSEN, Jr., Texas 
ROBERT TAFT, Jr., Ohio 
PAUL J. FANNIN, Arizona 



(II) 



LETTERS OF TRANSMITTAL 

August 12, 1976. 
To the Members of the Joint Economic Committee: 

Transmitted herewith is a study entitled "The Economic Impact 
of Alternative Fiscal Policies." This study examines what might have 
happened in various historical periods had we followed a policy of 
balancing the budget or balancing the full-employment budget. It 
also examines the probable impact of another discretionary policy 
different from the one actually pursued. 

The views expressed in the paper are exclusively those of the author 
and do not necessarily represent the views of the Joint Economic 
Committee, individual members thereof, or other members of its staff. 

Hubert H. Humphrey, 
Chairman, Joint Economic Committeel 



August 11, 1976. 
Hon. Hubert H. Humphrey, 
Chairman, Joint Economic Committee, 
U.S. Congress, Washington, D.C. 

Dear Mr. Chairman: Transmitted herewith is a study entitled 
"The Economic Impact of Alternative Fiscal Policies." This study 
was prepared for the Subcommittee on Fiscal Policy by L. Douglas 
Lee of the committee staff. It forms a part of the subcommittee's 
continuing effort to analyze the appropriate role of fiscal policy in our 
economy. 

This study examines the probable impact of three alternative fiscal 
policies: Balancing the actual budget, balancing the full-employment 
budget, and a discretionary policy different from that actually pursued. 
The study examines three different historical periods and in general 
it concludes that no single fiscal policy rule is appropriate under all 
economic conditions. The study concludes that in almost all cases 
intelligent use of discretionary fiscal policy is superior to blind ad- 
herence to the balanced budget rule or the balanced full-employment 
budget rule. 

The views expressed in this paper are those of the author and do 
not necessarily represent the views of the committee, its individual 
members, or other members of the committee staff? 

Richard Bolling, 
Chairman, Subcommittee on Fiscal Policy. 



August 9, 1976. 
Hon. Richard Bolling, 

Chairman, Subcommittee on Fiscal Policy, Joint Economic Committee, 
U.S. Congress, Washington, D.C. 
Dear Mr. Chairman: Transmitted herewith is a study entitled 
"The Economic Impact of Alternative Fiscal Policies." The purpose 

(in) 



IV 

of this study was bo examine the probable impact of pursuing two 
often-discussed fiscal policy rule- balancing the budget and balancing 
the full-employment budget. At the same time a third more dis- 
cretionary policy was simulated. These experiments were run over 
three historical time periods representing different phases of the 
business cycle. 

The study reaches the following basic conclusions: (1) Over most 
of the period from 1965 to 1974 balancing the budget would have been 
a very poor policy to follow. It would have meant substantial losses 
in output and increases in unemployment with little if any improve- 
ment in inflation. (2) Balancing the full employment budget over this 
period offers some improvement over balancing the actual budget, 
but it i- no panacea. Over much of this period the full employment 
budget was close to balanced, so that bringing it into complete balance 
would have had little impact — either positive or negative — on eco- 
nomic performance. (3) In almost all cases discretionary policy 
proved superior to blind adherence to either of the fiscal policy "rules." 
In some cases the experimental discretionary policy was significantly 
better than the policy actually pursued. 

This study was prepared by L. Douglas Lee of the committee staff 
in consultation with other members of the Joint Economic Committee 
staff and F. Gerard Adams and Vijaya G. Duggal of Wharton Econ- 
ometric Forecasting Associates, Inc. The econometric simulations on 
which this paper is based were prepared by Drs. Adams and Duggal 
in consultation with the committee staff. Administrative and secre- 
tarial work was done by Beverly Park of the committee staff. 

The views expressed in the paper are those of its author and do not 
necessarily represent the views of the committee, its individual 
members, or other members of the committee staff. 

John R. Stark, 
Executive Director, Joint Economic Committee. 



CONTENTS 



Page 

Lot tors of transmittal in 

THE ECONOMIC IMPACT OF ALTERNATIVE FISCAL 

POLICIES 

Summary and conclusions 1 

Presidential budget concepts, 1970-76 3 

Studv results 6 

1965-69 6 

1969-72 10 

1972-74 15 

Conclusions 18 

Appendixes 

A. Appendix tables 20 

B. "Balanced Budget" Simulations for the U.S. Economy 29 

(V) 






Digitized by the Internet Archive 
in 2013 



http://archive.org/details/alterfiscOOIeel 



THE ECONOMIC IMPACT OF ALTERNATIVE FISCAL 

POLICIES 

By L. Douglas Lee 



SUMMARY AND CONCLUSIONS 

More than 5 years have passed since the American economy pro- 
duced at its full potential. For most of these years we have also been 
plagued by increasing prices. Many explanations have been advanced 
for the causes of these problems, but the ones most often heard by 
Congress relate to the Federal budget. Some people argue that the 
Government's chronic deficits are at the root of our economic prob- 
lems. These people propose a relatively straightforward solution: 
Balance the Federal budget. 1 

Others argue that the problem is not the deficit per se, but rather ex- 
cessive stimulus or restraint at an inopportune time. They suggest 
calculating the revenues and expenditures which would result from 
operating the economy at full employment and using the change in 
this full-employment balance as a guide for determining the appro- 
priate level of the actual deficit. A variant of this argument appeared 
several years ago when President Nixon suggested that expenditures 
should never be allowed to outrun the revenues that the tax system 
would generate at reasonably full employment. 2 [More recent studies 
of our long-term capital needs have suggested that by spending less 
than full-employment revenues, the Government could encourage 
saving and capital formation. 3 

This paper looks back in history and tries to determine what might 
have happened if we had followed two fiscal policy rules: First, 
balancing the actual budget, and second, balancing the full-employ- 
ment budget. Three time periods were examined: Mid-1965 to mid- 
1969, a period of substantial economic growth; mid-1969 to mid- 19 72, 
which spans an economic trough where growth fell sharply then rose 
sharply; mid-1972 to mid-1974, which covers a peak with real growth 
first rising rapidly then turning negative. Several tax and expendi- 
ture changes were used in each case to achieve the desired balance. 

After examining the fiscal policy rules, a third, discretionary 
policy was tried. This policy was different in each case, but the 
object was to experiment with some combination of fiscal and mone- 
tary policy which economists might have regarded as reasonable at 
the time. 



1 For example. Fee "Controversy Over Proposed Mandatory Balancing of the Federal Budget," Con- 
gressional Dipest, March 1976. 

2 "The U.S. Budget in Brief, Fiscal Year 1972," p. 6. 

s See, for example, Capital Needs in the Seventies, Barry Bosworth, James S. Duesenberry, and Andrew 
S. Carron, Brookings Institution, 1975. 

(1) " 



Three basic conclusions emerge Prom this analysis: 
(l) Over most of the period from 1965 to 1974 balancing the budget 
would have been a very poor policy to follow. It would have meant 
substantia] losses in output and increases in unemployment with Little, 

if any. improvement in inflation. 

_ Balancing the full-employment budget over this period offers 
some improvements over balancing the actual budget, but it is no 
panacea. Over much of this period the full-employment budget was 
close to being balanced, so that bringing it into complete balance 
would have had little impact — either positive or negative — on 
economic performance. 

(3) In almost all cases, discretionary policy proved superior to 
blind adherence to either of the fiscal policy rules. In some cases 
the experimental discretionary policy was significantly better than the 
policy actually pursued. 



PRESIDENTIAL BUDGET CONCEPTS, 1970-76 

The poor performance of the U.S. economy in recent years has 
generated renewed interest in different fiscal policy rules. Changing 
views of the two most frequently discussed rules — balancing the actual 
budget and balancing the full-employment budget — can be traced 
through successive presidential statements. 

In July 1970, President Nixon set forth the budget policy of his 
administration: 

At times the economic situation permits — even calls for — a budget deficit. There 
is one basic guideline for the budget, however, which we should never violate: 
Except in emergency conditions, expenditures must never be allowed to outrun 
the revenues that the tax system would produce at reasonably full employment. 
When the Federal Government's spending actions over an extended period push 
outlays sharply higher, increased tax rates or inflation inevitably follow. 1 

The following January, the President declared that "the 1972 budget 
has a historic identity of its own ... it adopts the idea of a 'full- 
employment budget,' in which spending does not exceed the revenues 
the economy could generate under the existing tax S} T stem at a time 
of full employment. * * * The full-employment budget idea is in the 
nature of a self-fulfilling prophecy: by operating as if we were at full 
employment, we will help to bring about that full-employment." 2 

The full-employment budget rule was continued in the 1973 and 
1974 budgets. When the President presented his fiscal year 1974 
budget he was able to state the following: 

From 1971 through 1973, the full-employment budget principle permitted and 
called for substantial actual budget deficits. For this reason, some people have 
forgotten the crucial point that the full employment principle requires that 
deficits be reduced as the economy approaches full employment — and that it 
establishes the essential discipline of an upper limit on spending at all times. * * * 

As we look ahead, with the economy on the upswing, the full-employment 
budget principle — and common sense — prescribe a shift away from fiscal stimulus 
and toward smaller budget deficits. We must do what is necessarv to make this 
shift." 3 

Accordingly, the 1974 budget document shows a full-em pi oyment 
budget surplus moving in the direction of restraint from 1972 to 1975. 
Over this period the full-employment budget was projected to move 
from a $4.9 billion deficit to a $2.0 billion surplus. 

The discussion about shifting "away from fiscal stimulus and 
toward smaller budget deficits" introduces the idea that the level of 
the full-employment deficit is not the only relevant consideration. It 
suggests that changes in the deficit from one year to the next are also 
important. The full-employment calculation by definition separates 
the changes in the surplus or deficit caused by cyclical fluctuations 
from changes caused by other forces. Some economists would argue 
that these changes are the most useful measure of fiscal impact; they 
show whether the Federal Government is using its discretionary 



» "The U.S. Budget in Brief, Fiscal Year 1972," p. 6. 

2 "The Budget of the U.S. Government, Fiscal Year 1972." 

» "The Budget of the U.S. Government. Fiscal Year 1974.-^ 

(3) 
73-600—76 2 



policy 4 to provide more or less Btimulus to the economy relative to 
the preceding period. 5 Tim- over the 1972 bo 1975 period when the 
surplus wsls estimated to move steadily in the positive direction, fiscal 
policy would be characterized as restrictive throughout. 

By January of 1974 when the 1975 budget was presented, the ad- 
ministration was beginning to retreat from the idea that the full- 
employment budget is "a self-fulfilling prophecy." Rather than recom- 
mending spending as if we were at full employment, the President 
proposed a restrictive fiscal policy in the form of an increasing full- 
employment surplus. This policy, characterized as ''moderate re- 
straint," was justified as being consistent with the goal of slowing down 
the growth of demand to help check inflation. The rising full-employ- 
ment surplus was also dismissed as being "the result of the high infla- 
tion rate experienced in calendar year 1973 and expected to continue 
for the first half of 1974." 6 

Throughout 1974 there was much discussion about whether the 
full-employment budget concept remained useful, and whether the 4- 
percent criterion for full employment should be revised. In testimony 
before the Joint Economic Committee that year, the Council of Eco- 
nomic Advisers submitted a detailed statement discussing the full- 
employment budget balance and showing estimates of this balance 
based on a number of different assumptions — different potential GNP 
series, with and without inflation adjustments, and with a variable un- 
employment rate. 7 

The slowdown in economic growth anticipated in the President's 
January 1974 budget message turned, with the help of restrictive fiscal 
and monetary policy, into a full-fledged recession. As a result, what had 
been projected as a modest deficit of $9 billion turned into an actual 
deficit of almost $43 billion. In February of 1975, President Ford's 
first budget proposed a deficit of almost $53 billion for the coming 
fiscal year. In his commentar}^ he stated : 

I regret that my budget and tax proposals will mean bigger deficits temporarily, 
for I have always opposed deficits. We must recognize, however, that if the 
economic recovery does not begin soon, the Treasury will lose anticipated receipts 
and incur even larger deficits in the future. 8 

The words full-employment budget are nowhere mentioned in the 
President's 1976 budget message. In fact, one could easily infer that 
the President's first choice would have been a balanced budget, if this 
could have been achieved. 

In the 1977 budget message, attention is shifted from deficits to 
other considerations. The deficit forecast for 1976 had grown from $52 
billion to $76 billion, and the President's estimates for 1977 — $43 
billion — was widely viewed as unrealistically low. The deficit references 

* Calling changes in the full-employment budget "discretionary" is not totally accurate. Increases in the 
price level which are not wholly within policymakers' discretion can have a substantial impact on the full- 
employment budget. 

* For example, the February 1971 "Economic Report of the President" states: "The absolute level of the 
full employment surplus or deficit is of limited significance for indicating how much restraint or stimulus the 
budget would exert on the economy if it followed the full employment path, or indeed for indicating which of 
these directions its influence would take. Changes in the full employment surplus from period to period are 
much more important indicators of how much fiscal policy is moving toward contraction or expansion. The 
fact that the full employment budget has a surplus does not imply that the budget is not having an ex- 
pansionary impact on the economy; the effects may be expansionary if the surplus is declining. Similarly a 
budget with a deficit may be restrictive if the deficit is declining." (See p. 72.) 

* "The Budget of the U.S. Government, Fiscal Year 1975." 

7 "The 1974 Economic Report of the President: Hearings before the Joint Economic Committee," Part 1. 
« "The Budget of the U.S. Government, Fiscal Year 1976." 



in the President's message can be summarized in two sentences: "The 
total size of the budget and the deficit or surplus that results can sub- 
stantially affect the general health of our economy — in a good way or 
in a bad way. * * * The combination of tax and spending changes I 
propose will set us on a course that not only leads to a balanced budget 
within 3 years, but also improves the prospects for the economy to stay 
on a growth path that we can sustain." 9 

Thus from 1971 to 1977 the full-employment budget idea went full 
circle — from giving the budget a historic identity of its own to being 
practically ignored. 10 

During 1974 and 1975 we began to see a return to what was called 
the old-time religion of balanced budget policy. When the 1976 
budget document was released, the Secretary of the Treasury, William 
Simon, was quoted as being "horrified" at the size of the deficit 
projected. Administration officials began to talk about the time when 
we could get back to a balanced budget, and the budget document 
contained long-range projections which showed the gap between 
outlays and receipts narrowing and being closed by 1979, with a 
budget surplus projected in 1980. This emphasis on balancing the 
budget has continued up to the present. Secretary Simon summarized 
a statement defending the President's tax and spending cut proposals 
made in the fall of 1975 by saying: 

If we do act now, we can regain fiscal control and restore balance to the Federal 
budget which is required if we are to stabilize economic activity and provide the 
necessary environment for savings and investment in the future. ... If we do 
not act now the disappointing record of economic instability and chronic general 
budget deficits will continue into the future. 11 



• "The Budget of the U.S. Government, Fiscal Year 1977." 

i° It would be misleading to say that the full-employment concept was totally ignored in the 1976 and 1977 
budgets. The text of the documents, after the President's message, shows this calculation. Although the 
text does not characterize the fiscal policy implicit in these calculations, the projections show[the full-employ- 
ment surplus rising steadily from 1976 to 1981. The full-employment calculation is identified as an "analytical 
concept" whose purpose is unaffected by the level of unemployment used in the calculations provided that 
level remains fixed. 

11 Statement of Hon. William E. Simon, Secretary of the Treasury, before the Joint Economic Committee, 
Friday, Nov. 7, 1975. 



STUDY RESULTS 

Is view of this history of changing budge! concepts, it seems useful 
to examine the two fiscal policy rule- that have enjoyed some popu- 
larity in recent year — namely, balancing the full-employment budget, 
and balancing the actual budget. This experiment uses a macro- 
economic model to reproduce the actual course that the economy 
followed over three different periods of time — 1965-69, 1969-72. and 

172 ~ : After adjusting the model to reproduce what actually 
occurred, fiscal policy was changed to conform to one of the rules 
such as the balanced budget. This causes the model to produce the 
economic path which would have been likely had that fiscal policy 
actually been pursued. 

In the case of the balanced actual and full-employment budgets, 
the assumption i- made that monetary policy i- substantially 
unchanged. In all probability, monetary policy would change in 
response to a substantially different fiscal policy, but no one know- 
by how much. Therefore, the assumption of no change is probably 
the best assumption that can be made in examining the effect- of 
fiscal policy alone. This underscore- the fact that fiscal and monetary 
policies do not work in isolation but should be used a- complementary 
methods of influencing the course of the economy. 

In each of the time periods three different methods of balai. 
the budget factual and full employment) have been u<ed: (1) Chang- 
ing the personal income tax. (2; changing transfer payment- to persons, 
and (3) changing government purchases of goods and services. In the 
case where purchases of goods and service- are changed, they are 
split 33 percent to 67 percent between civilian and defense expendi- 
tures with half of that change being in wage payment-.- 1 

The following section contain- a discussion of (1) the policy of 
balancing the actual budget, (2) the policy of balancing the full- 
employment budget, and (3) a policy which might, at the time, have 
been regarded as somewhat more appropriate than either of the - 
than the policy actually pursued. 

1965-69 

From mid-1965 to mid-1969, the United State- enjoyed a period of 
substantia] economic growth interrupted only temporarily by the 
mild recession of 1966-67. Throughout most of this period the rate of 
inflation and the unemployment rate were both under 4 percent. At 
the same time, the Federal Government ran a modest deficit. 

Balancing the budget in a period of actual deficits necessarily 
mean- a reduction in expenditures or an increase in taxes. Accordingly, 
this policy would tend to curtail gross national product and raise the 
rate of unemployment. The simulations conform to this expectation 
throughout the 1965-69 period. The more interesting result is that 

ulationa were made using the Wharton Mark III Quarterly Model. 

. u experience over the 1965-74 p^ncd was that defense purchases, while generally declining, averaged 
75 percent of total purchases; pay averaged about 44 percent of defense purchases and 47 percent of 
civilian pure 

(6) 



balancing the budget via a reduction in Government purchases of 

goods and services has a much greater effect on the economy than 
balancing it via a reduction in transfer payments or a personal income 
tax increase. As table l 3 shows, balancing the budget in 1967 using tax 
increases or cuts in transfer payments would have reduced real CAP 
about $10 billion in the last 2 years of the period. However, balancing 
it by reducing purchases of goods and services reduced real GNP by 
even more, especially in 1967 when the actual deficit was the largest of 
the period. 

If the budget had been balanced from mid-1966 to mid-1967, real 
economic growth would have been between 1 and 3% percentage 
points lower than actually occurred depending on the method by 
which the budget is balanced. The unemployment rate was only modest- 
ly higher using income taxes or transfer payments to balance the 
budget, but was raised by almost 3 percentage points in 1967-68 when 
purchases of goods and services were used to balance the budget. The 
reverse phenomenon can be seen at the end of this time period when 
the actual budget was in surplus. Balancing the budget by increasing 
purchases of goods and services has a much larger impact on real 
growth than balancing it through an increase in transfer payments or a 
reduction in personal income taxes. 

On reflection, it is logical to expect a change in Government pur- 
chases to have a larger impact on the economy than a corresponding 
change in taxes or transfers. When personal taxes are reduced, for 
example, we would expect consumption to rise by less than the total 
tax cut because part of it would be saved. However, this model simula- 
tion shows economic impacts of changing purchases almost twice as 
large as those from changing personal taxes or transfer payments. The 
magnitude of this difference was surprising. 

TABLE l.-BALANCED BUDGET POLICIES (MID-1965 TO MID-1969) 





Mid-1965 to 


Mid-1966 to 


Mid-1967 to 


Mid-1968 to 




mid-1966 


mid-1967 


mid-1968 


mid-1969 


Real GNP, billions of dollars (annual average): 










Base solution. _ 


640.8 


666.6 


690.1 


719.3 


After changing: 




Purchases. 


639.9 


656.3 


664.2 


713.8 


Transfers 


640.3 


663.6 


679.0 


709.2 


Taxes . ... 


640.2 


663.2 


678.4 


711.4 


Percent change in real GNP (annual rate): 










Base solution.. r 


6.1 


2.8 


4.9 


2.5 


After changing: 










Pu rchases 


6.6 


-.7 


5.6 


9.0 


Transfers. 


6.1 


1.5 


4.3 


4.0 


Taxes 


6.2 


1.4 


4.6 


4.6 


Percent change in implicit price deflator (annual rate): 










Base solution 


3.1 


3.0 


4.2 


4.8 


After changing: 




Purchases 


3.2 


3.2 


4.3 


4.1 


Transfers . 


3.2 


3.3 


4.5 


4.6 


Taxes 


3.2 


3.2 


4.4 


4.5 


Unemployment rate (percent, annual average): 










Base solution.. 


4.1 


3.8 


3.8 


3.4 


After changing: 




Purchases 


4.1 


5.2 


6.7 


4.1 


Transfers 


4.1 


3.9 


4.1 


4.1 


Taxes 


4.1 


3.9 


4.3 


4.1 


Housing starts (millions, annual average): 










Base solution.. 


1.4 


1.1 


1.4 


1.6 


After changing: 




Purchases 


1.4 


1.1 


1.4 


1.6 


Transfers . 


1.4 


1.1 


1.3 


1.5 


Taxes 


1.4 


1.0 


1.3 


1.5 













3 For each table in the text there is a table in the appendix showing quarterly estimates and ot I 
tinent information. 



8 
The reason for this larger difference is twofold: First is the initial 

impact on ONP caused by a sudden reduction in Government pur- 
chases. In the initial impact, a reduction in purchases directly reduces 
GNP and in its secondary impact, the lower CrNP produce- fewer tax 
receipts and thus necessitates another expenditure reduction to 
maintain the balance. This spiral effect means that the change in 
expenditures necessary for a balanced budget is much greater than 
the change in tax collections or transfer payments. The second reason 
for the large difference is the treatment of employment in the expendi- 
ture cut. As mentioned earlier, half of the expenditure cut is assumed 
to be a reduction in wage payments which translates directly into 
a lower level of employment. 4 

The full-employment experiment over the same period of time 
shows a similar pattern. (See table 2.) First, one should know that 
the full-employment surplus or deficit (shown in appendix table 2) 
was never very large, the greatest deficit being $11% billion and the 
greatest surplus being $S}o billion. One would not expect changes of 
this magnitude to have large effects on the economy. This expecta- 
tion is borne out when the full-employment budget is balanced using 
transfer payments or personal income taxes. Once again, however, 
when the full-employment budget was balanced by changing purchases 
of goods and services, the effect both on the unemployment rate and 
the rate of growth of real GNP was much greater. In the early part 
of this period reducing purchases produced a much lower growth 
rate than other policies and in the latter part increasing them to 
achieve balance in the full-employment budget produces a much higher 
growth rate. It is interesting to note that in this particular time 
period changing transfer payments or personal income taxes produce 
a more stable growth path than changing purchases. 

The impact on the rate of inflation both in the balanced budget 
case and the balanced full-employment budget case appears to be 
very small. As noted in the paper, appendix B, prepared by Ger- 
ard Adams and Vijaya Duggal, the results in some cases seem to 
go in the opposite direction from what might first be expected. This 
is not an unusual result in econometric simulations and it results 
from the response of price to cyclical changes in productivity. When 
the economy is stimulated enough to increase economic growth, the 
improved productivity that normally accompanies increased growth 
offsets some of the price pressure from the increased demand which 
also accompanies the increased growth. The conclusion is that moder- 
ate variations in budget policy have little effect on the inflation 
rate. 

In table 3 one can see the results of discretionary fiscal and monetary 
policies which might have been pursued from 1965 to mid-1969. 
These policies are not intended to produce the optimum growth path 
which hindsight might allow an experimenter to produce, but rather 

* The current dollar change in expenditures should not be overexaggerated when compared with the 
tax and transfer change because the model is designed to respond to "real" or purchasing power changes. 
Since balancing the budget requires changing nominal dollars, a conversion is required. This is done by 
dividing the nominal dollar amount by the appropriate implicit price deflator. Consider the following ex- 
ample: In 1971, balancing the budget required a personal tax increase of $27.3 billion or a cut in purchases of 
$38.4 billion, nowever, if the tax increase is deflated by the personal consumption deflator and the purchases 
cut is deflated by the Federal purchases deflator, the changes in real purchasing power translate into $20.3 
billion for the tax change and $24 billion for the purchase change. Part of the tax increase would come from 
reduced savings and part from reduced consumption. Therefore, the reduction in "real" consumption 
would probably be less than $20 billion. The difference between the two policies is about $4 billion in real 
purchasing power as compared to about $11 billion in current dollars. 

The argument for transfer payments is approximately the same as for taxes. However, since most transfer 
payments go to low income people who save little, one would expect transfer changes to have a slightly 
more powerful impact on the economy than an equivalent tax change. 



to approximate a set of policies that might at that time have been 
regarded as reasonable by many economists. 

Specifically, in the first simulation, personal income taxes were 
increased by $5 billion in 1966, $10 billion from the first quarter of 
1967 to the second quarter of 1968 and $12 billion from the third 
quarter of 1968 to the second quarter of 1972. An attempt was made 
to smooth out the rate of increase in the money supply and, especially, 
to avoid the large reductions in the rate of growth of the money 
supply that occurred in 1966 and 1967. These policies produced a 
slightly lower growth rate in the real gross national product and 
slightly higher average unemployment rate. 

TABLE 2— BALANCED FULL EMPLOYMENT BUDGET POLICIES (MID-1965 TO MID-1969) 

Mid-1965 to Mid-1966 to Mid-1967 to Mid-1968 to 
mid-1966 mid-1967 mid-1968 mid-1969 

Real GN P, billions of 1958 dollars (annual average): 

Base solution 640.8 666.6 690.1 719.3 

After changing: 

Purchases 642.1 658.8 679.1 718.6 

Transfers 641.5 663.9 680.7 713.7 

Taxes 641.7 663.4 682.5 714.4 

Percent change in real GNP (annual rate): 

Base solution... _ 6.1 2.8 4.9 2.5 

After changing: 

Purchases .- 5.2 1.8 5.5 5.3 

Transfers 5.9 2.0 4.7 3.5 

Taxes 5.9 2.0 4.7 3.9 

Percent change in implicit price deflator (annual rate): 

Base solution 3.1 3.0 4.2 4.8 

After changing: 

Purchases 3.2 3.1 4.1 4.5 

Transfers 3.2 3.2 4.3 4.6 

Taxes 3.2 3.2 4.3 4.6 

Unemployment rate (percent, annual average): 

Base solution 4.1 3.8 3.8 3.4 

After changing: 

Purchases... 3.8 4.8 5.1 3.7 

Transfers - 4.0 3.8 4.0 3.8 

Taxes 4.0 3.9 4.1 3.9 

Housing starts (millions, annual average): 

Base solution 1.4 1.1 1.5 1.6 

After changing: 

Purchases 1.4 1.1 1.4 1.6 

Transfers 1.4 1.1 1.4 1.5 

Taxes — L4 LI L3 U> 

TABLE 3.— DISCRETIONARY POLICY (MID-1965 TO MID-1969) 

Mid-1965 to Mid-1966 to Mid-1967 to Mid-1968 to 
mid-1966 mid-1967 mid-1968 mid-1969 



Real GNP, billions of 1958 dollars (annual average): 










Base solution.. 


640.8 


666.6 


690.1 


719.3 


1st simulation 


639.9 


664.1 


686.9 


715.5 


2d simulation . 


640.1 


667.0 


688.9 


714.7 


Percent change in real GNP (annual rate): 




Base solution 


6.1 


2.8 


4.9 


2.5 


1st simulation 


5.7 


2.8 


4.9 


2.5 


2d simulation.. 


5.9 


3.0 


4.4 


2.3 


Percent change in implicit price deflator (annual rate): 










Base solution 


3.1 
3.2 


3.0 
3.2 


4.2 
4.3 


4.8 


1st simulation 


5.0 


2d simulation 


3.2 


3.1 


4.5 


5.0 


Unemployment rate (percent, annual average): 










Base solution 


4.1 
4.1 


3.8 
3.8 


3.8 
3.8 


3.4 


1st simulation 


3.5 


2d simulation 


4.1 


3.8 


3.6 


3.4 


Housing starts (millions, annual average): 










Base solution 


1.4 


1.1 


1.4 


1.6 


1st simulation 


1.4 


1.1 


1.4 


1.5 


2d simulation 


1.4 


1.2 


1.4 


1.5 


Short-term interest rates (annual average): 










Base solution 


4.8 


5.5 


5.5 


6.5 


1st simulation 


4.8 


5.2 


4.8 


5.7 


2d simulation 


4.5 


5.1 


5.1 


5.7 


Long-term interest rates (annual average): 










Base solution 


4.9 
-4.9 


5.5 
5.5 


6.3 
6.1 


6.8 


1st simulation 


6.3 


2d simulation 


4.9 


5.3 


6.1 


6.4 



10 

In the second simulation an attempt was made to avoid some of the 
bousing crunch of 1966. In-trad of allowing the Federal Reserve's dis- 
count rate to rise to 4 1 -: percent as actually occurred, it was maintained 
at 4 percent from the third quarter of 1965 to the first quarter of L967. 

Other changes in tax and monetary policy made in the first simulation 
were also maintained. This second simulation produced 100, ooo more 
housing start- in 1966 than the base -olution, hut had very little 
impact on other economic indicators. 

In all case- the changes had little impact on the rate of inflation. 
Where the inflationary impact does appear to he significant, it can be 
attributed to the productivity loss associated with a tax increase and 
the resulting slowdown in economic growth. Contrary to normal 
expectations, restrictive fiscal policy tends to aggravate inflation. In 
no case are the changes very large. 

1969-72 

Turning to the second set of experiments — covering the period 
1969:.S to 1972:2 — one sees much larger impacts of different fiscal 
policy rules. In the early part of this period the economy was very 
sluggish with some periods of declining activity, and the last few 
quarters show growth rates substantially above our long-term trend. 
The rate of unemployment rose throughout the first half of this 
period, and then leveled off at just under 6 percent. 

Table 4 indicates the disastrous consequences that would have 
resulted from a balanced budget policy. Instead of an unemployment 
rate rising from 3.6 percent to just under 6 percent and remaining 
steady at that level the unemployment rate would have risen through- 
out the entire period. If the budget had been balanced by changing 
purchases of goods and services, the unemployment rate might have 
been 4 percentage points higher than what was actually observed. If 
the balance had been achieved by changing personal income taxes or 
transfer payments, the resulting unemployment rate would have been 
about 1 percentage point higher than the base solution. 

It is vital to note the behavior of inflation throughout this time 
period under the various t balanced budget scenarios. There is little 
effect on inflation in the first year of the simulation period. In the 
second year, however, inflation averages 0.8-0.9 percentage points 
higher and in the third year it averages about 0.5 to 1.0 percentage 
points higher. Since excess demand pressures were nonexistent over 
most of this period, reducing output by balancing the budget does not 
have a favorable impact on inflation but rather an unfavorable one 
due to the slowdown in productivity that accompanies a lower growth 
rate or a decline in real output. 



11 

TABLE 4.— BALANCED BUDGET POLICIES (MID-1969 TO MID-1972) 



Mid-1969 to Mid-1970 to Mid-1971 to 
mid-1970 mid-1971 mid-1972 



725.8 
725.5 
725.5 


705.2 
722.2 
720.5 


724.4 
737.8 
741.8 


-.3 


2.8 


7.0 


-3.5 
-1.0 
-1.2 


.4 
.9 
.7 


6.7 
5.6 
5.9 


5.1 


4.6 


3.1 


4.8 
5.1 
5.2 


5.5 
5.4 
5.5 


3.7 
4.2 
4.0 


4.0 


5.7 


5.9 


4.0 

4.0 
4.0 


8.5 
6.0 

6.1 


9.7 
6.6 
6.9 


1.3 


1.8 


2.4 


1.3 
1.3 
1.3 


1.7 

1.7 
1.6 


2.0 
2.0 
1.9 



Real GNP, billions of 1958 dollars (annual average): 

Base solution.... 724.4 731.4 766.0 

After changing: 

Purchases 

Transfers 

Taxes 

Percent change in real GNP (annual rate): 

Base solution 

After changing: 

Purchases 

Transfers 

Taxes 

Percent change in implicit price deflator (annual rate): 

Base solution 

After changing: 

Purchases 

Transfers 

Taxes 

Unemployment rate (percent, annual average): 

Base solution 

After changing: 

Purchases 

Transfers 

Taxes 

Housing starts (millions, annual average): 

Base solution 

After changing: 

Purchases 

Transfers 

Taxes 

A special note is necessary to explain the treatment of price and 
wage controls in the period following August 15, 1971. Technically 
controls are handled by exogenous adjustments to the constant 
factors in the relevant model equations. This means that in the alterna- 
tive simulations, controls are assumed to have exactly the same impact 
that they had in the base solution. Clearly, if controls had been applied 
differently with the alternative economic policies, the path followed 
by prices might have been different. Like monetary policy, however, 
the response of controls to different fiscal policies cannot be antici- 
pated and therefore the constant assumption is most appropriate 
for examining the impact of alternative fiscal policies. 

At first glance, the difference between the unemployment rate 
produced by changing purchases as opposed to changing taxes or 
transfers appears very large — about 3 percent in the last year of the 
period. The difference between the change in purchases and the change 
in personal taxes or transfers required to achieve a balanced budget 
is $10 billion or less. However, one must remember that Government 
purchases of services included the labor services of Government 
employees. Therefore, a reduction in purchases of goods and services 
has the direct effect of reducing Government employment and thereby 
raising unemplo} r ment as well as the less direct, macroeconomic effect 
of reduced Government spending. An increase in taxes or a reduction 
in transfer payments has only the indirect macroeconomic impact 
on unemployment. 



'3-600- 



12 

Another point worth Doting is the size of the change necessary to 
balance the budget. For example, in 1971 the actual deficit averaged 
about $22 billion. However, in order to balance the budget by raising 
income taxes we would have had to increase taxes by $25 billion, to 
balance it by reducing transfer payments we would have had to 
reduce them about $31 billion, and to balance it by reducing purchases 
of goods and services, would require a reduction in purchases of over 
$ 38 billion. This illustrates the point that tax receipts will fall when 
the Government reduces its support to the economy. Lower spending 
reduces the deficit but lower tax receipts partially offset this initial 
effect. 

Since the balanced budget scenario produced such undesirable 
results, turn to the alternative rule of balancing the full-employment 
budget. The result of this policy is illustrated in table 5. The first 
thing to know about this scenario is that for over half of the period, 
the full employment budget was very close to balanced. In the first 
three quarters of this period there was a full-employment surplus of 
about $10 billion and in the last two quarters there was a full-employ- 
ment deficit of $6 to $10 billion. For the quarters in between, the 
full employment budget was close to balanced. Accordingly, one would 
not expect a balanced full-employment budget policy to cause much 
larger changes than those which actually occurred over most of this 
period. This is exactly what the simulations show. 

In the early part of this period, balancing the full-employment 
budget means increasing expenditures or decreasing receipts. Once 
again, a change in purchases of goods and services has a much larger 
impact than a change in transfers or taxes. When purchases of goods 
and services are increased by the $10 billion required to balance the 
budget, the unemployment rate is reduced almost a full percentage 
point. Conversely, in the last two quarters of the period when pur- 
chases are reduced by the $6 to $10 billion necessary to balance the 
full-employment budget, the unemployment rate is increased about 
half a percentage point. Since the unemployment rate was between 
3 '■■! and 4 percent in late 1969 and early 1970, the policy of balancing 
the full employment budget drives it even lower. At the end of the 
period when the actual unemployment rate was between 5/2 and 6 
percent, and the full-employment budget was in deficit, balancing 
the full-employment budget drives the unemployment rate even 
higher. These changes become more obvious when the quarterly data 
shown in appendix table 5 is examined. 



731.7 
727.9 
728.3 


734.4 
735.7 
735.7 


763.1 

768.2 
767.2 


-.3 


2.8 


7.0 


-.6 
.1 




2.2 
2.7 

2.6 


5.5 
6.3 
6.1 


5.1 


4.6 


3.1 


4.9 
4.8 
4.8 


4.7 
4.5 
4.5 


3.5 
3.6 
3.7 


4.0 


5.7 


5.9 


3.3 
4.0 
3.9 


5.5 
5.6 
5.5 


6.0 
5.6 
5.6 


1.3 


1.8 


2.4 


1.3 
1.3 
1.4 


1.8 
1.9 
1.9 


2.4 
2.4 
2.4 



13 

TABLE 5.— BALANCED FULL EMPLOYMENT BUDGET POLICIES (MID-1969 TO MID-1972) 

Mid-1969 to Mid-1970 to Mid-1971 to 

mid-1970 mid-1971 mid-1972 

Real GNP, billions of 1958 dollars (annual average): 

Base solution 724.4 731.4 766.0 

After changing: 

Purchases 

Transfers 

Taxes 

Percent change in real GNP (annual rate): 

Base solution 

After changing: 

Purchases 

Transfers 

Taxes 

Percent change in implicit price deflator (annual rate): 

Base solution 

After changing: 

Purchases 

Transfers 

Taxes 

Unemployment rate (percent, annual average): 

Base solution 

After changing: 

Purchases 

Transfers 

Taxes 

Housing starts (millions, annual average): 

Base solution 

After changing: 

Purchases 

Transfers 

Taxes 

This experiment suggests that balancing the full -employment budget 
under all circumstances can at times be destabilizing. Pursuing this 
policy in the late 1969-early 1970 period drives the unemployment 
rate below what is often regarded as a sustainable long-run level; 
pursuing it in the latter part of 1971 and early 1972 aggravates an 
already too high unemployment rate. 

Table 5 also shows that from early 1970 to the end of 1971 when 
the full-employment budget was very close to being balanced, the 
unemployment rate was steadily rising. Since fiscal policy was fairly 
neutral (the change in the surplus from one period to the next was 
fairly small), the slowdown in the economy must be attributed to 
other forces. 

With respect to inflation, the already mentioned productivity effects 
of changes in real output can again be observed. But the more inter- 
esting observation is the length of time necessary for increases in 
demand to be reflected in the rate of inflation. The unemployment 
rates generated by balancing the full-employment budget in the late 
1969 and early 1970 period (a maximum of 1 percent less than the 
4 percent in the base solution) reflects an economy with excess aggre- 
gate demand. However, there is no appreciable impact on the aggregate 
rate of inflation for at least 1 year. From mid-1970 to mid-1971, the 
inflation rate was roughly the same as the base solution, but during 
the last half of 1971 and early 1972. the GXP deflator averaged about 
one-half percentage point higher. This indicates that the maximum 
effect of the excess aggregate demand is a sustained higher rate of 
inflation in the second year after the conditions of excess demand 
existed. Again one must remember that these simulations assume no 
response from wage-price controls to the change in aggregate demand. 

Turning to table 6, one can see what a more flexible fiscal policy, 
different from the two balanced budget rules, might have produced. 



14 

Declining mic activity in the early part of this period suggest 

that the very low unemployment rates could not be sustained for 
very long. Therefore, in order to stimulate economic growth and 
prevent the unemployment rate from rising as high as otherwise 

seemed likely, a tax reduction might have been appropriate. At the 
same time, given the relatively high rate- of inflation and the slowly 
increasing money supply, some increase in monetary growth would be 
ssary to permit the tax reduction to stimulate the hoped-for 
increase in real output. Accordingly, the money supply might have 
been allowed to expand somewhat more rapidly. 

In the line labeled "first simulation" in table 6, personal taxes were 
reduced by $8 billion from the third quarter of 1969 to the third 
quarter of 1970. Thereafter, the personal tax reduction was slowly 
reduced until it became zero in the middle of 1971. The money supply 
was allowed to increase about 6^ percent as opposed to the 6 percent 
that actually occurred. In the line labeled "second simulation" taxes 
were reduced by $10 billion throughout the entire period. Increases in 
the money supply were about 6.8 percent, although they followed a 
much smoother pattern in the second simulation than in either the 
base solution or the first simulation. 

TABLE 6— DISCRETIONARY POLICY (MID-1969 TO MID-1972) 

Mid-1969 to Mid-1970 to Mid-1971 to 
mid-1970 mid-1971 mid-1972 

Real GNP, billions cf 1958 dollars (annual average): 

Base solution 

1st simulation 

2d simulation 

Percent change in real GNP (annual rate): 

Base solution 

1st simulation.. ' 

2d simulation 

Percent change in implicit price deflator (annual rate): 

Base solution.. 

1st simulation 

2d simulation 

Unemployment rate (percent, annual average): 

Base solution 

1st simulation 

2d simulation 

Housing starts (millions, annual average): 

Ba se sol uti on ., 

1 st simulation 

2d simulation 

Short-term interest rates (annual average): 

Base solution 

1st simulation 

2d simulation 

Long-term interest rates (annual average): 

Base solution. 

1st simulation 

2d simulation 

The results of this particular policy are in many respects more at- 
tractive than the base solution and more attractive than what would 
lune occurred under either of the balanced budget rules. Although the 
unemployment rate rises and falls in the same general pattern, the 
peak unemployment rate is 5.4 percent in the second simulation as 
compared with the 6 percent that actually occurred. Equally as im- 
portant is that, instead of remaining near peak levels for \}{ years, the 
unemployment rate declined by about 1 percent during that time. The 
easier monetary policy is reflected also in lower interest rates and 



724.4 
728.2 
730.0 


731.4 
738.4 
744.1 


766.0 
772.2 
784.3 


-.3 
.3 
.7 


2.8 
2.8 
3.7 


7.0 
6.8 
7.3 


5.1 
4.8 
4.7 


4.6 
4.3 
4.0 


3.1 
3.5 
3.4 


4.0 
4.0 
3.9 


5.7 
5.5 
5.2 


5.9 
5.4 
4.8 


1.3 
1.4 
1.4 


1.8 
1.9 
2.0 


2.3 
2.3 
2.4 


8.5 
8.5 
8.3 


5.9 
6.0 
5.7 


4.9 
4.8 
4.6 


8.0 
8.0 
8.0 


8.3 
8.3 
8.1 


7.8 
7.8 
7.6 



15 

higher levels of housing starts. The more stable economy produced by 
this policy also causes a more satisfactory performance of the rate of 
inflation. 

1972-74 

Turning to the last time period to be examined, the overall results 
are substantially the same as in previous time periods. From mid-1972 
to mid-1974 the budget was very close to being balanced. As might be 
expected, balancing the budget in the first half of this time period 
when the actual deficit averaged over $13 billion has a far greater 
impact on the econonvy than balancing it in the last half when the 
deficit averaged less than $2 billion. 

TABLE 7.— BALANCED BUDGET POLICIES (MID-1972 TO MID-1974) 

Mid-1972 to Mid-1973 to 
mid-1973 mid-1974 

Real GNP, billions of 1958 dollars (annual average): 

Base solution 820.6 

After changing: 

Purchases 

Transfers 

Taxes... 

Percent change in real GNP (annual rate): 

Base soluti on 

After changing: 

Purchases 

Transfers 

Taxes 

Percent change in implicit price deflator (annual rate): 

Base solution. 

After changing: 

Purchases 

Transfers. 

Taxes... 

Unemployment rate (percent, annual average): 

Base solution 

After changing: 

Purchases. 

Transfers 

Taxes 

Housing starts (millions, annual average): 

Base sol uti on 

After changing: 

Purchases 

Transfers.. 

Taxes.. 

The timing of the budget deficits — large at the beginning of the 
period and small toward the end — means that a balanced budget 
policy would have caused a severe shock to the economy in late 1972, 
which would have gradually damped as time passed. For example, 
balancing the budget by reducing Government purchases would have 
raised the unemployment rate by about \Yi percent in late 1972 bur 
by just over one-half percent in 1974. 

The behavior of inflation is somewhat more interesting in this 
scenario than in the previous ones. The normal productivity effects are 
observed in the early parts of this period, and in the latter parts of the 
time period balancing the budget through tax and transfer payment 
changes has little effect. However, when the deficit i- small enough that 
balancing the budget through reduced purchases has little impact on 
economic growth and productivity, there seems to be a modest, though 
significant, reduction in the overall rate of inflation. This is probably 
the result of the higher unemployment jrate produced in the previous 



804.9 
814.0 
813.1 


826.9 
827.3 
828.1 


5.4 


-2.2 


5.0 
4.5 
4.5 


-1.5 
-2.1 
-1.9 


6.3 


10.1 


6.7 
6.8 
6.7 


9.7 
10.2 
10.2 


5.2 


5.0 


6.7 
5.3 
5.4 


5.7 
5.3 
5.3 


2.4 


1.7 


2.4 
2.4 
2.3 


1.7 
1.6 
1.6 



16 

year by balancing the budget. This tends to confirm the previous 
observation that the unemployment rate seems to influence the aggre- 
gate inflation rate after about a l-year lag. 

Table 8 illustrates the balanced full-employment budget scenario 
for mid-1972 to mid-1974. Throughout this period, fiscal policy be- 
came steadily more restrictive. The result was low rates of growth in 
lit?:') and recession in 1974. Balancing the full-employment budget 
over this time period would have been a substantial improvement 
over the policy which was actually pursued. These simulations suggest 
that while balancing the full-employment budget would not have 
prevented the recession in 1974, it would have lessened the reces- 
sion's seventy. Economic growth would have been between one-hall" 
and 1 percentage point higher over the 2-year period, and unem- 
ployment would have been correspondingly lower. Further, it is 
quite likely that recovery would have begun mueh sooner under the 
balanced full-employment budget policy. 

TABLE 8.— BALANCED FULL EMPLOYMENT BUDGET POLICY (MID-1972 TO MID-1974) 

Mid-1972 to Mid-1973 to 
mid-1973 mid-1974 

Real GNP, billions of 1958 dollars (annual average): 

Base solution.. 820.6 836.0 

After changing: 

Purchases 

Transfers 

Taxes 

Percent change in real GNP (annual rate): 

Base solution 

After changing: 

Purchases 

Transfers 

Taxes 

Percent change in implicit price deflator (annual rate): 

Base solution ■ 

After changing: 

Purchases 

Transfers 

Taxes 

Unemployment rate (percent, annual average): 

Base solution 

After changing: 

Purchases 

Transfers 

Taxes 

Housing starts (millions, annual average): 

Base solution 

Aftei changing: 

Purchases 

Transfers 

Taxes 



Table 9 illustrates the results of a more flexible policy unfettered 
by the rule of a single principle. Federal transfer payments were 
increased beginning in the third quarter of 1972 by $4 billion. These 
payments were gradually tapered off to zero in the third and fourth 
quarters of 1973 but increased again by $2.5 billion in the first half 
of 1974. This is a rough estimate of the funds that might have been 
employed had a countercyclical grant program been in place. Per- 
sonal income taxes were reduced by $10 billion beginning in the second 
quarter of 1973, and the reduction was maintained through the end 
of the period. Federal nonmilitary spending was increased modestly — 



814.9 
817.5 
816.7 


843.8 
837.0 
838.5 


5.4 


-2.2 


5.6 
5.1 
5.1 


-.2 

-1.0 

-.6 


6.3 


10.1 


6.6 
6.6 
6.5 


10.2 
9.9 
9.8 


5.2 


5.0 


5.7 
5.2 
5.3 


4.0 
5.0 
5.0 


2.4 


1.7 


2.4 
2.4 
2.3 


1.6 
1.6 
1.7 



17 

$5 billion by the end of the forecast horizon. Both of these measures 
were intended to provide general stimulus to counter the coming 
recession. 5 In the last few quarters of this period, the money supply 
was allowed to grow about 2 percent more rapidly than in the base 
solution to accommodate the hoped-for expansion in real output. 

TABLE 9.-DISCRETI0NARY POLICY (MID-1972 TO MID-1974) 

Mid-1972 to Mid-1973 to 
mid-1973 mid-1974 

Real GNP, billions of 1958 dollars (annual average): 

Base solution 

1st simulation 

2d simulation 

Percent change in real GNP (annual rate): 

Base solution . 

1st simulation 

2d simulation 

Percent change in implicit price deflator (annual rate): 

Base solution 

1st simulation 

2d simulation 

Unemployment rate (percent, annual average): 

Base solution 

1st simulation 

2d simulation 

Housing starts (millions, annual average): 

Base solution 

1st simulation 

2d simulation 

Shcrt-term interest rates (annual average): 

B3se solution 

1st simulation. 

2d simulation 

Long-term interest rates (annual average): 

Base solution 

1st simulation 

2d simulation 

The results of this first simulation show a signi 
economy in the last part of 1973 and early 1974 with no ill effects in 
the form of increased inflation. 

In the second simulation, an attempt was made to avert the housing 
slowdown even further by maintaining the Federal Reserve's discount 
rate at 5.1 percent from the first quarter of 1973 throughout the entire 
period instead of allowing it to rise to 7.9 percent as actually occurred. 
This causes the money supply to increase substantially faster in 
1974 as shown in appendix table 9. The result is again a stronger 
economy with some improvements in housing starts. 



820.6 
823.5 
823.5 


836.0 
845.7 
849.0 


5.4 
6.0 
6.1 


-2.2 

-1.6 

-.6 


6.3 
6.3 
6.3 


10.1 
9.8 
9.6 


5.2 
5.1 
5.1 


5.0 
4.6 
4.5 


2.4 
2.4 
2.4 


1.7 
1.8 
2.0 


6.0 
6.1 
5.8 


9.4 
9.5 
7.1 


7.6 
7.6 
7.6 


8.2 
8.2 
7.6 


titly 


stronger 



5 A $10 billion tax reduction was recommended tc Congress by the Joint Economic Committee in March 
1974. 



CONCLUSIONS 

After examining three different policies over different phases of the 
business cycle, three ba>ic conclusions emerge: 

(1) Over most of the period since 1965 balancing the actual budget 
would have been a very poor policy to follow. It would have meant 
substantial lo^<es in output, and increases in unemployment with very 
little, if any. improvement in inflation. 

(2) Balancing the full-employment budget offers some improvement 
over balancing the actual budget but it is no panacea and it is not a 
self-fulfilling prophecy. Over much of this period the full-employment 
budget was so close to balanced so that bringing it into complete 
balance would have had little impact — either positive or negative — 
on economic performance. 

(3) In all cases examined, the "rule" of balancing the budget by 
reducing Federal purchases would have been inferior to the policy ac- 
tually followed. In mo^t cases, the policies pursued could have been im- 
proved, in some cases significantly. The experimental discretionary 
policy was significantly better than the policy actually pursued, and 
in two of the three cases produced the most desirable economic path. 

Table 10 shows a comparison of the best and worst cases examined 
in this paper. This designation is sometimes arbitrary, and it is based 
on overall economic performance relative to sustainable long-run 
trends. In some years the difference is small, but in most of the period, 
a well-chosen discretionan^ fiscal policy can significantly improve 
overall economic performance. 

(18) 



! -2; 



-o'E 



19 



ff> tO I ■— 1 



<fi^ u»rx or*. 



cvicn 



ld en 

CO «T 



lO MIX ^nr-» «*Tf 

to to to trito cvjcsj 



T»E 

2 



ON 

— en 



?I 



CD Cn 

-o'E 

is 



2 


en en 

to f 


o 


2-o 


r- 


■h E 


to 


2 


en 








Q 




s. 


oo en 



■iE 



Oi-~ 
*-to 
-.ocn 



tn oo cm , 



CO 00 PsLf) 



•a-oo cn< 



to-* en. 



to evj r*. t© 



cote 
to tn 
to to 



rx cnjcm enesi •—>• 
I cd tri co lo rt . 



r. 



as 



en to 

— en lt) to 
^- co 
to to 



cvicsi 
coco 



cn-a 
i = 
"5-° 
Eg 

•Co 
O 05 



1-3 



E E 



■— </) ra c 



| Q0<u co 



cotJnjnjOCTjnjO 



<rc o> S ro ~ Si 



° tz <*> ° "csro} o 2? S o r ; 

S a>oo5: pco£ ^oqS: S a, 

g § S | °*> 

<X> B O ^- = 



4) a> 






s| 

en 5 

T a> 

-D.C 
E~- 

o a> 

^ 2 
<-° _ 
en c 



.- -. 



Ecf 



OO 

g 



x 



n 



g I 

W x 
_ 

5 I 



O cm oo oo «» o uo uo «r o o ^r «»• — o uo tflinuj p» cm oo -- o 

oo o po — oo' *r «■' uo' ^' uo' uo' po° cvi ■«•' ^-' — I — I — ' — I I ^r to ^-' uo' evj 

KKl»» - 

po — ■ oo oo uo csi oo ro oo oo co ^r oo --• -* p*. r^ to tO to *»■ to oo id 

po po uo cri pj uo uo ^r po po p-i po po ■«•' V .—J ^-i _; _; p.; ob r-^ r^ co' 

Krtot ** -|- 

oo cm oo ■«»• moji uo cm oo to «■ C -- — * to iri/)in oo p^ oo ^- — • 

<vi ^ g cm" to' po co ^-' •*»■' *r «»•' co uo ^-' *r *i — • — • — •' oo' ob oo oo — I 

p-~ — OO o OOMtD OO I/O UO ^- UO P- — i CM I/O ^T ^- ^ PO CD OO OO OO 

— oo oo rf od *j-' «r *»■' ^-' ^r ^-' po in ^ ■«•' .-! ■— ! — I — I oo p-^ r~; r^ co 
tO tO to 

PO O ~* OO tD P- O OO P-* CM -^ tO I — •— i CM UO **■ PO OO OO OO^-^J" CM 

p~' cm pu p.! to to p~ po c*i ■vr •& po to rr *r — i — ' -^ — « r~C to p>- p-» — 
O to to 

t£> OO UO rf UO P-* CO CD OO «— « OO P- tO CM PO UO «y PO PO po ^j-oooo oo 

CO O O I/O in *T UO PO PO TT PO PO U5 «? f <— < — ' »-• — « U0 ^ : ^j-' t' oo' 

COOOOO , 

p^ocm oo r—r-oo oo ocm—« oo oo cm *»• «*• *»• «a- po oo oo uo ^- oo 

r~i po" ^J csj — ^ — ' rt «a-' tri uo uo' po tb ^' «3- -~ — ■ — «' — ■ uo' ^-' uo' oo' p.j 

L-1ISIS. ^ - 

to to CO 

O — — tt CM — O O f uo ^r OO tOOCM «■ TJ-VfO CO LO cm — • — 

U-' O OO «J-" CM OO OO "3-' ^T "T ^r oo <x> •» «r ~ ~ — ' ~ oo oo' OO OO PO 

ipr^to ^-< 

UO O — • C3 CM UO PO CVI OOIOIO OO OO C3 O CM CM CM — OO O 10 UO UO 

— -< L/O «-r PO* o*-^«— • Csi CM CMCM CO tO^-'^- ^h ^-i ^N ^ UO UOUOUO CM 
<X)U3 tO 

CMtOfO oo oo «r P~ oo to>— O OO O OO CO — < CM — < O PO OO po CM to 

--cm'pJ o to' cm' cm' cm' cm'oopo po to po'oo •— "' « — — ^- oo^j-'^j-' — -i 

uo to tO I I I I ^^ 

to to to I III 

oo r~ to OO O CM -* o oo o o to ^-p-l-^ OO OO OO OO CM CO CM CM — i 

Nidts * f\i*t" ri oifici m t'roro ^r 

toto to I 

to to to I 

UOOOO CM »00 tO <IMN OO OO OO OO -- — — — P^ ««■ tO tO CM 

OOOOO CO OPOPO OO COCOOO OO OOO0P0 -^ —i^rt ," III •— i 

U^ UO to I I I I I 

to to to I 

— i ~- CM r-» 00 — < PO OO O.OO OO COOOOO PO POPOPO r- OOp-OO o 

oduouo' po uot'^- oo ^■'«a : ^ : oo coco'po -h ^--^^ ^j-' ^^-'td po 

tototb + 

OO UO «»■ -- 0OCMCO ~> COPOPJ OO OOOOOO >* >* T "3" OO P~ OO OO *J- 

cbodod oo oo oo" od co po 1 po po po' pocopo —I ^^^ to' to to to' -^ 

«■ ^J" -3" I 

totoo ~r 

ooooto ^r — pocm er> COOOOO ~- ^j.,^—, UO UOUOUO OO tooooo — ■ 

po uo uo' oo o oo oo i— • cm •-" ~+ •»' ^r «*•' ^r •— • r* »* »^ to' to to to' #— < 
to to to 



"i Z- = t= c= <u ^ 



o ■= oc re ^: 



'. re Si 



re >< ="o-C i; re >< 2 o -= i; ™ 
wrere^^i^wrePTio 31 - 

<-> « S; _2 a» i 

oj 03 <£ c; CO <f 



E 
c 
— o 



2 £ 



>- re X =' 



t-ts 1\_ Q-r-l 



(20) 



21 



OO if-r-. Cn *J- OJ LO LO OCMCM ■* en oo oo to to LO IB r-~ «010U3 O O r>» CM 
u-> cm' co' *d- i— < «a-' co co to to lo' lo co cm cd co — — — — •» to «a- lo oo cm od ■*>•' «a- 

R £££ + 7 +++ 



\D Tj- tO 

»r r-! od 

CM — « — < 



CSJ CJ! O CM 



on in 



■ to tO CO 



IO) tO tO LO tO CO tD CO ( 



+ + +++ 



co -o-coco — i — — . 



tO ID CO O ON«f «3- CM' 



lo toto^ co cm — — « < 



i- T "O" «*■ 



— CD O O 



«* "*-=f ^> 



-=r co oo to 






en oo co oo 



«» moo to tocnoo r-» oo. 

LO LO LO to CO COCOCO CO Lf">«3-« 



to to to 

lo oco oo 



i T CO 00 



■OO CT> CM— CM LO 



CM r~. tO CM CM CM CM 

to to to 



"? ID lT> CO 



t— t •— i .— t ^h ID lo lo to cn 






CM r- — CM 

— r-^ to' to 

7 l I I 



oo lo to en 



co *r to to 



oc to to 

I I I 



to — CMCM r-» — 



>er «* «3- t co to «a- *3- 



#— . r— i — en en en en en co oototo 

17 ill 



OCOCO CM tO LO LO OO 



• en CD CM CM CM • 



CO tO to OO LO LOtS-' 



'LOCO CO CO CM CM CM CM CM CM CO LO CO ^" — .-irtrt LO LO tO lo en CM r- LO *a- 
> tO tO I ^ H I I I 

' to to v I i J I I 



CM — CD OO OO — . 



00 CM en CD 



cm— cm co en cm — to to tor 



tO CM CM — COCMCM CM CM CO CO CO LOCO" 

£8£g I III 



en lo— «cn 



— LOCVJ-H 

7IM 



en en en en 



— to -O 
to tO to 
tc to to 



CO COCOCO CO 



+ 1 



r~ loco to to< 



.r~ OO CM 



i CM CO COCOCO CO 



I 1 I 



to to to to 



-" — CMCO 

I +1 I 



NC" oo r-~ oor 



co co co co 



— « oenco 



COCO CO CO 



LOOO — — CMtvJ 



co cocoi 



en r~- 0000 



*r«g-«a-o co cococo 
+ + ++ + 



oo CDcn o to 



co rocoM co cococo ■— • 



to to to to 



leo'** — r- — r 



LO LO LO LO 



tO I — tO I — CD — I _i i 

+ + ++ ^ 



encnenr-. — no" 



oeno — — — • 



CO CM CM 
CM CM CM 

to to to 






= e c <u "C 



to 0* 

■ CO Zl 



c "i " 



CM ^T CO LO 



Isl-2 

- "Eg" 



! i ! a> i 1 

! ! ! <o ', ! 

! ! !"" ! ! 

i i i e I 

i i ■> i e i 

i . i CO i 

I I I to" I I 

i i i B ■ ' 

' ! '-2 ' | ! 

oi^ to '?= ' **%! to 

= £ »- '(=«= = »>- 

5>!S>£ '.o.S'aJS* 



to to toco —I 



— CO 

+ I 



COq-«3- 
I I I 



co «a- t 
I I I 



Etc 

jo-S 

CS. L. 

E° 



^ ; cz c c 



CO x 



g CQ <t ___■— QQ<; 



cj a> 



"" "O to a > 

Q> QJ CC J_t 



oo 



00 0)0 CD CD ( 



in — < o — — — • in m m coco 

cnjcnicni 

r-~ i — i — 



tnoooo WLiin mm* uir^r- cnj r-» r-» r- co oo o cnj in 
•— <— - r- to to r-' to to * * co cnj * co 



— CMCNI 
+ + + 



ICOO CO * uT) * m * I — cio r-~ 



in oo — * ro < 



in in conic incsiin 
to in in r- to to r^ r-.' to CD — • o 

+ + + 

(SO 



in* tern* oo — tocvicsj co * i 



to csj rsj cnjcnj cnj 
r~« r--r». 



> r— to ocici co m m inic 



OLOlO OCU? OOr>-o 



(•—CM *0 — CO CD ■ 



rvjoooo "Tron «nr>» rococo — . 



oiooo inioo cd — cnj to to * in * co 



in cm cnj r- r 



1 + + 

CDOO* 



to in in to to to oor»r-~ co r-» r- 
I+ + 



< cnj tororo ctioocnj cm C) co 



CO CO CO .— i ^ ^ <*D IT) LT> UDcDtD rviDl/) ,— t ^ .— i 

7 1 ' 



fmoi to cd — r- oo to in** ico— *cnjcnj co — «m oocnjcnj 



cnj en — to in « 
to to to 



coco* cococo — — — m*m tototo 



tO •"9- CD 00 r~» * 



>CD O CD O < 



co r- co co — — CD" 



co o cnj cnicnjcnj vfl-in co*co •— < • 
oo oooo 
to to to 



in*m tototo ininm cnjcnicni 

7 I I 



CD CD CD * CO CO CO •— ' < 



>CD r-» * CO ' 



> in cd CD oo i — in. 



oo in oo * * * 

r^ l — r~- 

to to to 



* * * co co co 



i — « tn * * in in in CD o • 



coco cnj 

7 I I 



tO CD CO COCDOO CNJ * CO 



■ co to toinco oocnj. 



— " OO CNJ CO CNJ CNJ CNJCNJCNJ COCOCO t— I — . 

r- to ^~ 

to to to 



* * * tn in i 



to — to cd cor 



CO CD Csl tO — CD 



ini-r~ i — I 
tototo I I I 

to to to I 



CNJ CO CNJ CO CO ( 



< — — < mm* in m in *r-»CD — cni 



= <? I 



CDOOO O — • 



cd cd — or-.** i — to in cnj to cd —to* 



> tn oo *mm cococo cococo oo- to in in mini 



to oo oo 001 



ocNj cor-CNi inin* r-. — - — cnjoi 



co c-cd co coco 



l CO CO CO CO CO — • ■— • • 



in in m in in tn 



r— • oo •— « co co 
I++ 



■ co r- — « • 



OlOO 00 C 



* OO CNJCNJ. 



■ — i mirifl- in in in * to to cop»-r-. 
+ + + 



— CNJCNJ r-ron CDCDCD *' 



* oo* cococd 



cniN-r- oor-r-» cococo cococo — — — mm* inin* totom — mm 
tototo ~i — I — h 



tor-r- *** cd < 



m in m minco oooo< 



icdcnj — — — 



tO tO tD CDCDCD — ' 



** tototo — — — 

i I I 



mm in * * ■ 



a> I ! I ! I ! 

ro I i i i I . 

"3 ! I ! ! ! ! 

3 i 

C 

ro !''..'' ' 



— oo 
cococo 






•IJ-.l 

■fEro oo"S 

1111 

'-' 00 — cnj a> 00 
75 £ 

a> <u 

ce o_ 



OlT CO 



II. 



£•— 2 "" £•- °o5° 2 " 2 — 2 2 2-2. o— o.2 a-o o.2 o 

o 2 = £~ =3^o = =--o = =.Eo = 3 = o I o-o =3 
".i E t^.i E-2 "J Ee"IEc «".§ EJS "\§ eS»Ee 

v»^ - —"> i ^c>o'«^^CO<''^^nJ'''^ J ^-«''» J ^ 3 «' > ^ - 

ra w"CQ- ra wT3c: ra tf) , C* rfTO WO*- ra w"Oc flI tf)"O a,n w'D 
00 — cnj pQO- cnj-— CO^^cnj — 00 — cnj i CO — cnj a>00 — cnjLi-00^.cnj 



23 



to —- 1 p- o «a- uoo«r en cv/i^to r-. (orvo co oom to ooo 10 

id co oo' oo' od to r~»' p~." — • — i cm' cm 'd o> id p~ cm' cm' cm ^-i od oc od co oo 

oo «a- muo — 

p-. p-p^r- | 

OO IOOOID ^T CM "tf P- I/O OOOO,^-) OO CM r-« O f — • ■— ■ O CO tD 00 00 oo 

o — ' to in to oo' ud jo id id to u-i "">' oStoiv cm' cm' cm' cm id «3-' ^y «a- *r' 

p- co tj- «a- ~-" 

— < tncMCO ir> p- no to od o— >_* 0"> owai cm oooo oo oo *r «a- Ln 

oo" id r-.' id id »*' >*' ■* ~* coM m ' id o id to' cm cm cm — cm ' —J ^ oo 

IT) -.fOfO — " CM 

cm «a* cm •— * oo to oo oo to o p-~ ^ oo rviriN ■— < oo oo oo p^ ^r o o p-^ 

r-J r^-*CT5'r^ CM " CM* ^rcOrX LO OO tO tO CM rnrn^i lt> m to to CM 

■er ONM " CM 

^ "^^ I 

i— I COP~.tO OO ITIMO OO fOOgO °* tOCOtn O OO OO OO CO fOOOr-> -3- 

cm id p-.' id cm' i— < ««r iriio^' 10 oo' id id cm r-lr-~ —< ~^ odd co 

*3" OCMCM I •—' .—«.—<.—< CM 

p- r~- r~ r-~ I 

oo O^-lo cm inuit oo tocooo o ooco-3- oo oooor-. oo lt; — ><z> o 

to oo to ^ o' od od od ^j- id id .<->■ to oo to to •— • •— I •— • — « to in to id od 

CO OCMCM -H r-H 

^ r-r-r^ | 

co r~ r~ o co i~»r<«t co oot^ oo too — < p-» p- i — to oo p-tom co 

oo' <4r ■— i o «rf od to to' to to' to r~.' m' od to to •— < •— « ■-* •-« id ^a-' lo' id oo' 

s s^pt i i i i 7 

CM toooo OO P~--O0 —I P-» U0 j-, CM — i CO CO to in in «* ^ CM oo OO 00 

P-* O CO »— * CM I H *3" «=3" *3" *a-' t!0 P** id in •— • ,-h .— ( p— t tO in in id CO 

CM r- -"CMCM I ~« 

•— < OOf tO LOOCO tO fMP»00 ^» CM 00 0O CO «3" CO CO 00 tO 00 0O OO 

cm' iHrt'ci " in <— •' — < ^j- ««•' «a- «»•' "3- to" «a-' -a 1 i— ! p— • •— < i— < id id id to' — < 

CM — «CMCM I I I ~m 

r— p~r>.p-» I I I 

cm •—■oooo i-« oomp» *r ir>o--< cm "3-cmcm cm cocooo «d- r~ir>uo to 

-* CM' CM CM CM* U0 CM CM' id K0 tO tO "^ "=»■ "»' «3- -^' rir-iwi "T t' «3" -3"' CM 

CM CM CMCM i I | I I 

P^ P^| — I — I I I I I 

•-» 00 ^- OO CM OO 00 P^ f OCMCO ID 00 tO ID CO CO CO CO ■— i U^ CM CM CO 

uo cm p..' p-^ csi i— i •— • •— ' uo ir> uo uo co cm' co co' <— '< •— " ~* — «' cvi cm cm cm" «a-' 

CM COCMCM | III 

p^ r-» p»p^ I III 



oo tooo 
cm oococo 



tO tOlD to 
CO CM CO CO 



o 
5o 



o-2 MroJ 



oS5 



QJ \2 

!'5bJS^ 

! 03 o c 
i-C ^ TO 

I ° 
i it 

!< 



■ ^ TO u C Q> 

re £ j; t> ^ i. oj 









24 



O rscsito ^ co — *<*> & 1 tors is, rs co **• ur> co csicsicsi to cotrt^j-to to moots 

to° ob to' ^- od to rs to' — csi csi csi lo to tri tri csj csi csi csi 06 00 06 06 o cr> ndoi 

00 rsoooo »-• »-■ — — 1 

"• K *"* 5 I I II 1 

on oooors ^- cotncsi in 00 cr> o o> csitoto >» ^-***r co csjcocsioo o» toocvj 

o to csi — to" «t tri iri tri tri iri to uri to jS oS csi csi csi csi »ri tri tri tr> to «a- doico 

rs arsis I »-< •— i I I 

rs rsrsrs I I I I 

— ac ji lt> oncsi — o» "«r csj co o oototo csi csjcsicsi o oooionto m mrsio 

cri 00' csi — to tri to o .-■ csj csi csi to" iri iri iri csj csi csi csi csi ,-• — — ■—• co csj — « — 

tn mtoto I cm esjcsicsi 

rs rsrsrs 1 

csj OcsitO 00 orsrs to csjrsrs o 00 rs rs — — csi — . to -r lo ai 00 rs csj rs rs 

rs 1 00 — o csi co csi csi csi co csi csi to iriiriiri csi csicsicsi to to to to 1° csj csi — — 

«=r -a- .nuo I csi csjcsicsj 

rs rsrsrs , , , , 

— incsirs a> couoco on oo~>— « o> orsps o o — — « co csicocsito **■ — onto 
csi csj to tri csi — csi csi «r tri ^' iri tri toaSiri csi csicsicsi — • •— < — -- co co csioSoS 
rs rsrsrs I | , , , 

o> — torn csi oococsi rs to**-ir> o rsoooo 00 oncr>e?> to Mintoo o cocsj^r 

to e> — — o aio'o *r -a-' *r t° to iri iri tri — — —J — to to to to _l. 00 00 00' 00 

" SSS - -- - --- 

co — tors «*• oocoin «* oa>er> 00 torsto rs 000000 en oocDontn co — csjitj 

ai cri co co" xy «=r «* *r to to iri iri iri iri iri iri — — — — u-j iri iri iri — ai 000 

— > CSJCSJCsl II _1_ — CSJCSJCSI 

rs rsrsrs I I I I T^ 



lOOtO -« 



' — ; — csj coc 



LOOO) 


CSJ 


0000 


ir> 


UT5 tO tO 


— 


OCSICSJCSI 


00 


CSI 00 — 


*T TfO 


to 


*r lo m 


"■ 


— — — 


td 


to to toco 

+ 


CO 

7 


IT) UT5 tO 

777 



CO coo 
to tors' 



1 — — to 



csi O •—•to 
rs rs rs' 1 * 



O) xj- co — 



I III 



CSI to C7>" 



csi ootnco 
csi — — — 

I Ml 



CX>00 OO 



CSI CO CO **■ 



on tors csi 
*r ^ *r o 



rsoooo 
rso-icj 



I I I 



OOUOLD CO CSK-Csl «!■ CSICSJCO 

cocoai csi — — — tri iriiriiri 

co csi csi 1 111 

rsrsrs I III 



to touo CO 
csicoco •-< 



~+ tocsi rooo 
csi csicsicsici 



to csi 



I I 



rstouo 
csico'co' 



= = co o c a> 2P = 



-a 

oil 






Q-r-r-- 



. c c a> 
: -2ciraOJ I - 

iS-gSSSl" 



c«2 ' S c cr a> 

5b S3 .2 l<5.2"5b!3. 

c: a> J2_= co o 

. _ 2 co c5°o = 

,_a.r-r- *; "; ,_a.r 



OC CO, 

co o 



EM 

11 



to w 

oo> 

*- 00 

-a -a 



00 to 00 
_il— csi 
+ l I 



\£ I 



CO CO £ 

r— -C 

O CO 



f=Oj< 



. CO rj ^ c?> O ^ ^- 

■a v) 2. 
a> co co*; 
oou. ca <t 



25 



•ct>-^ o~r~~oo r~csi«- coco^*- touoco r~.r~.tr> tocsjto to — o 
! r~~' od i-" csj csj tri ur> *r csj csj csj w'W«t r~" r~" i~~ od r~" r~! crioo'^r 

777 



01--0 «*•— «to tr> oo i~» o^^i 

o r~" o' to' to' to LOirJLrJ lo'lo" 
r~.i-~.o~ 



«-^- to — ooo 
csj csj csj ^ tt ' co' 



I I I 



— ito*t toco — « o~>csjoo cr> uo ot. csjco- 
o-> no r~" to to r~. — csj .-i tri tri *r csj csj ( 






oo oo to aoo>* 
i~~ t~~ r~! csj to' to 



oh oo u-> its to i~~ co enir> — ■— «csico i — oo uo 
! ti- *r csj csj co csj csj csj uo" it" uo esi csj csj iritriirj 



too «*■ NOO 



I I I 



-Mm o->r~.t~~ 

csj oS r~~ csj csj co' 

■~r -~r uo 
r~. i~~ r-~ 



O CO CSJ O — « CO O— < 

lo ir> >r> esi csi csj Louri' 



o ooo COCOCSJ 



— — CSJCslCSJ 

I I I 



Cj3^f o 
CO ^T in 

r~.r~.r~. 



CM co co 
o'o— ' 



i~~coo 



Or~«t ooo— * totoco 
to" in u"> — csj c\i «3-' «a-' *s- 



oicnr 
i~~r~.'r 



mm m ooco 

to to to' oo' -- in 
— csicsi 

I I I 



CO CO O ^ OT> CO 

oStd — «» coed 
r~.r~.r~. II 



«*■ to co oo to "* r~.oocy> co co O inin> 
to' in m in m m ■— « — ' .— J to to to" od oo < 



mors 
into to' 



Nino o~ o to -hi 



cvjooo intO(0 ooonm 
' — «' r~~ r~I r~* 



it~»to — coa> oocsjo 

i oo oo' to* to' to co' o — i i 
— csjcsi 

I I 1 



— 1 1~~ in o — uo to co — 



CSJCSJOO 1010"* OOON CftCSjCSJ 

oo' oo i~~ oo oo oo' to r~~" r~! — ' oo' oS 



I I 1 



csjr~. a> csj in. 



) |~, C\JrH ( 



t— i in r~. cm — — tomm 
csjcsjesi ill 
r~.r~.r~~ II 



CSJCOCO toto«* COCOCsl ^j-toco tOCsJCO 

— --■« oooo'cc oo'odoo' «~i"«3"t~~ csioSo' 

I 17 



— *»-oo coino «*coco toinm co**-- 

in od oS cvi — — iri in m" co co co' — — . 

CSJCSICSJ I I I 

r~.r~.r~. II 



to to LD 

00 oo oo 



en oooo — e\j r~~ 
r~! r~! i~~ cvi cm' to' 



+ 1 I 



CO CO m •* ** ^ in m in *<■ ^r »*• 

co co co — — — 00 00 30 f~~ l~~ l~~ 



re c c ~ r^ 

.2 o— o.° o— o.S.a ~- 0.2.05 



2 ; ; ;X ; ; j 

1 i : !§ : : : 

s" i S is i i \a 

O I • J g I J I gj 



+ ' I 



sfss 



-CSI 



='"5 c 

ot-o'c 

^h csj <u 

o 

EL 



o 


o 


o 


~ 


O 


a 


o 


E 




o 


o 


0) 


a 


o 


a 


CJ 




c 


a 


B 


B 


a 




cr 














































S a 






re 


EC 


B 




re 


IB 


I/} 




re 


re 


JB 

F 




re 


re 


CJ 




re 


re 


jj 




re 




c 


a 
E 


a 
E 


■ 

E 


c 


a 
E 


3 
E 


re 


o 


a 
E 


Z3 
E 


o 


a 
E 


a 
E 


B 
E 


r 


a 
E 


a 
F 


(= 
re 


c 


E 


Is 


a 


















i/j 












B 






t_- 


■ 




— CL- 




■ 


— 




CI 


-r 


■?o 






re 


~ 




ii 


re 


-r 




(LI 


re 


tq 




•i 


re 


*^ 


re 




— 


CNJ 


E 




"* 


CSJ 






-' 




t; 




— , 


CSJ 


M 




— 


CSJ 


■ 




»■< 







§E 



26 



APPENDIX TABLE 7.-BALANCED BUDGET POLICIES (1972:3-1974:2) 



1972:3 1972:4 1973:1 1973:2 1973:3 1973:4 1974:1 1974:2 



Real GNP, billions of 1958 dollars (annual rate): 

Base solution. 798.1 814.2 832.8 837.4 840.8 845.7 830.5 

After changing: 

Purchases... 790.5 791.7 815.1 822.1 829.8 835.5 822.2 

Transfers 7S6.3 807. 5 824.2 828.0 831.9 836.9 821.9 

Taxes 795.9 8C6. 3 823.0 827.1 831.8 837.5 823.1 

Percent change in real GNP (annual rate): 

Base solution. 8.3 9.5 2.2 1.6 2.4 -7.0 

After changing: 

Purchases 6 12.4 3.5 3.8 2.8 -6.2 

Transfers 5.7 8.5 1.9 1.9 2.4 -7.0 

Taxes 5.3 8.6 2.0 2.3 2.8 -6.7 

Percent change in implicit price deflator (annual 
rate): 

Base solution 4.1 5.5 7.3 3.3 8.6 12.3 

After changing: 

Purchases 3.2 8.0 7.4 8.3 8.0 12.4 

Transfers 4.6 6.3 7.8 8.5 8.7 12.8 

Taxes.. 4.7 6.0 7.6 8.4 8.7 12.7 

Unemployment rate (percent): 

Basesolution 5.5 5.3 5.0 4.9 4.7 4.7 5.2 

After changing: 

Purchases 6.5 7.7 6.5 6.1 5.5 5.5 5.9 

Transfers 5.6 5.3 5.2 5.1 5.0 5.0 5.5 

Taxes 5.6 5.4 5.2 5.2 5.0 5.1 5.6 

Housing starts (millions, annual rate): 

Basesolution 2.4 2.4 2.4 2.2 2.0 1.6 1.6 

After changing: 

Purchases 2.4 2.4 2.4 2.1 1.9 1.5 1.6 

Transfers 2.4 2.4 2.4 2.1 1.9 1.5 1.5 

Taxes 2.3 2.3 2.3 2.1 1.9 1.5 1.5 

Percent change in money supply (Ml) (annual 
rate): 

Basesolution.... 8.7 7.1 7.8 5.6 4.6 5.9 

After changing: 

Purchases 8.2 5.7 6.6 5.1 4.8 6.2 

Transfers 8.6 6.7 7.3 5.2 4.5 5.9 

Taxes 8.5 6.6 7.2 5.2 4.5 6.0 

NIA Federal budget, surplus (+) or deficit (— ) 

Basesolution -9.8 -25.6 -11.2 -7.4 -1.7 -2.3 -1.5 



827.1 

820. 2 
818.6 
820.1 

-1.6 

-1.0 
-1.6 
-1.4 



9.4 

8.6 
9.3 
9.2 

5.2 

5.8 
5.5 
5.6 

1.6 

1.6 
1.5 
1.5 



7.6 

8.0 

7.7 
7.8 



-1.3 



A l 



APPENDIX TABLE 8.-BALANCED FULL-EMPLOYMENT BUDGET POLICY (1972:3 1974:2) 

1972:3 1972:4 1973:1 1973:2 1973:3 1973:4 1974:1 1974:2 

Real GNP, billions of 58 dollars (annual rate): 

Base solution. 798.1 814.2 832.8 837.4 840.8 845.7 830.5 827.1 

After changing: 

Purchases 797.3 804.4 824.8 833.0 842.2 851.3 840.4 841.2 

Transfers 797.9 811.0 828.2 832.9 £38.2 845.3 832.8 831.9 

Taxes 797.8 809.9 827.0 832.1 838.4 846.5 854.6 834.6 

Percent change in real GNP (annual rate): 

Base solution... 8.3 9.5 2.2 1.6 2.4 -7.0 -1.6 

After changing: 

Purchases 3.6 10.5 4.0 4.5 4.4 -5.0 .3 

Transfers 6.7 8.8 2.3 2.6 3.4 -5.9 -.3 

Taxes 6.2 8.7 2.5 3.1 3.9 -5.5 

Percent change in implicit price deflator (annual 
rate): 

Base solution 4.0 5.5 7.3 8.3 8.6 12.3 9.4 

After changing: 

Purchases 3.2 6.8 7.8 8.6 8.5 12.6 9.5 

Transfers 4.3 6.0 7.5 8.4 8.5 12.3 8.9 

Taxes 4.5 5.8 7.5 8.3 8.5 12.1 8.7 

Unemployment rate (percent): 

Basesolution 5.5 5.3 5.0 4.9 4.7 4.7 5.2 5.1 

After changing: 

Purchases.. 5.6 6.4 5.7 5.1 4.3 3.9 4.1 3.7 

Transfers.... 5.5 5.3 5.1 5.0 4.8 4.8 b. 2 5.2 

Taxes 5.6 5.3 5.1 5.0 4.8 4.8 5.2 5.0 

Housing starts (millions, annual rate): 

Basesolution 2.4 2.4 2.4 2.2 2.0 1.6 1.6 1.6 

After changing: 

Purchases 2.4 2.4 2.4 2.2 1.9 1.5 1.6 1.5 

Transfers 2.4 2.4 2.4 2.2 1.9 1.5 1.6 1.5 

Taxes 2.4 2.3 2.3 2.1 2.0 1.6 1.7 1.6 

Percentage change in money supply (Ml) 
(annual rate): 

Basesolution.... 8.7 7.1 7.8 5.6 4.6 5.9 7.6 

After changing: 

Purchases.. 8.6 6.5 7.3 5. 5.2 6.7 8.7 

Transfers 8.7 6.9 7.5 5.5 4.7 6.2 8.1 

Taxes 8.6 6.8 7.5 5.5 4.3 6.3 8.2 

Change required to balance full-employment 

budget' -1.6 -19.1 -10.2 -2.0 +8. +14.9 +20.8 +26.1 

NIA Federal budget, surplus (-r) or deficit (-): 

Basesolution -9.8 -25.6 -11.2 -7.4 —1. —2.3 —1.5 —1.3 

After changing: 

Purchases -8.7 -14.0 -5.9 -7.1 —7. -11.4 -13.3 -15.4 

Transfers -8.4 -10.2 -4.0 -6.9 -9. -14.4 -17.2 -20.5 

Taxes.... -8.2 -8.2 -3.5 -7.2 -10. -15.4 -19.0 -22.9 

i Positive sign implies additional purchases or transfer payments but a reduction in persona I taxes. 



28 



APPENDIX TABLE 9.-DISCRETI0NARY POLICY (1972:3-1974:2) 



1972:3 1972:4 1973:1 1973:2 1973:3 1973:4 1974: 



1974:2 



Real GNP, billions of 58 dollars (annual rate): 

Base solution 798.1 814.2 

1st simulation.. 800.2 816.5 

2d simulation 800.2 816.5 

Percent change in real GNP (annual rate): 

Base solution.. 8. 3 

1st simulation 8.4 

2d simulation 8. 4 

Percent change in implicit price deflator (annual 
rate): 

Base solution.. 4. 

1st simulation 3. 8 

2d simulation. 3.8 

Unemployment rate (percent): 

Base solution. 5.5 5.3 

1st simulation.. 5.5 5.2 

2d simulation 5.5 5.2 

Housing starts (millions, annual rate): 

Base solution 2.4 2.4 

1st simulation 2.4 2.4 

2d simulation 2.4 2.4 

Short-term interest rate: 

Base solution 4.9 5.3 

1st simulation 4.9 5.4 

2d simulation... 4.9 5.4 

Long-term interest rate: 

Base solution 7.6 7.5 

1st simulation 7.6 7.5 

2d simulation 7.6 7.5 

Percent change in money supply (Ml) (annual 
rate): 

Base solution 8.7 

1st simulation 7. 5 

2d simulation.. 7. 5 

N I A Federal budget, surplus (+ ) or deficit (— ): 

Base solution -9.8 -25.6 

lstsimulation -15.3 -29.1 

2d simulation -15.3 -29.1 



832.8 
835.1 
835.1 


837.4 
842.3 
842.2 


840.8 
848.5 
848.9 


845.7 
854.7 
856.7 


830.5 
841.0 
845.2 


827.1 
838.6 
845.1 


9.5 
9.4 
9.4 


2.2 
3.5 
3.4 


1.6 

3.0 
3.3 


2.4 
2.9 
3.7 


-7.0 
-6.6 
—5.4 


-1.7 
-1.1 
—.1 


5.5 
5.6 

5.6 


7.3 
7.5 
7.5 


8.3 
8.4 
8.5 


8.6 
8.3 
8.3 


12.3 
12.1 
11.9 


9.4 
9.0 
8.7 


5.0 
4.9 
4.9 


4.9 
4.7 
4.7 


4.7 
4.5 
4.5 


4.7 
4.4 
4.4 


5.2 
4.8 
4.7 


5.1 
4.7 
4.5 


2.4 
2.4 
2.4 


2.2 
2.2 
2.2 


2.0 
2.0 
2.2 


1.6 
1.6 
1.8 


1.6 
1.7 
2.0 


1.6 
1.7 
1.9 


6.3 
6.3 
6.3 


7.5 
7.6 
6.6 


9.9 
10.0 
7.2 


9.0 
9.1 
6.2 


8.3 
8.3 
6.3 


10.5 
10.4 
8.7 


7.6 
7.6 

7.6 


7.6 

7.7 
7.6 


8.0 
8.0 

7.6 


8.0 
8.0 
7.4 


8.2 
8.2 
7.4 


8.7 
8.7 
7.8 


7.1 

7.6 
7.6 


7.8 
7.9 
2.9 


5.6 
8.4 
-.2 


4.6 
9.3 
8.6 


5.9 
7.5 
11.7 


5.9 
7.9 
11.2 


-11.2 
-13.8 
-13.8 


-7.4 
-19.4 
-19.0 


-1.7 
-13.0 
-11.9 


-2.3 
-12.7 

-10.8 


-1.5 
-14.6 
-12.0 


-1.3 

-13.0 

-9.6 



Appendix B. "BALANCED BUDGET" SIMULATIONS FOR 

THE U.S. ECONOMY 

By F. Gerard Adams and Vijaya G. Duggal, Wharton Econometric 
Forecasting Associates, Inc. 

The unprecedented current upsurge of inflation has revived interest in "old 
fashioned" concepts of fiscal discipline. It has been suggested that balancing the 
budget will tend to check inflation. Yet many economists have argued that, 
particularly in the trough of the business cycle, balancing the budget will have 
serious impacts on employment and production with relatively little effect on the 
rate of inflation. This paper summarizes some simulations of Ihe Wharton model 
over recent historical periods to test what would have happened if the Federal 
Government budget had been in balance. 

Alternative Balanced Budget Policies 

The tests were carried out over three periods— 1965.3 to 1969.2, 1966.3 to 1972.2, 
and 1972.3 to 1974.2. The first of these periods, is a time of boom interrupted 
temporarily by the quasi-recession of 1966-67. The second period represents a 
recession, and the third represents the upswing which has culminated in the 
current inflation. 

With the exception of only a few quarters — early 1966 and during the tax 
surcharge in 196& — this is a time of substantial budget deficits. Thus, during most 
of this period we make cuts in spending or increases in taxes in order to achieve 
budget balance. This gives a misleading picture of the economic setting on which 
budgetary changes have been imposed. There are times when stabilization policy 
would call for surpluses and others when deficits would be appropriate. At times 
a policy of budget balance may even be destabilizing. 

In each case we have tested three alternative policies to balance the budget: 

(1) Change in the personal income tax; 

(2) Change in transfer payments to persons ; and 

(3) Change in government purchases of goods and services. 

The first two policies involve relatively simple adjustments. But the Govern- 
ment purchases policy involves numerous changes in the model assumptions, viz 
the assumption that changes in purchases are split 33 percent to 67 percent between 
civilian and defense expenditures, that half of the change in spending is in wage 
payments, and that the Government wage rate is not affected. The last point 
particularly is important since as a result changes in Government purchasing 
have significant direct impact ©n Government employment. 

In each instance, we have first adjusted the model so as to provide a base 
solution equal (or almost equal) to the actual developments of the period. Then 
alternative solutions have been run, which can be compared to the base solution, 
with the model programed to make the required policy adjustment to achieve 
budget balance. 

Simulation Results 

Tables 1, 2, and 3, present results of the three policy simulations over the three 
simulation periods. On the top of each table, we present the base solution budget 
deficit (national accounts concept). Secondly, we compare the impact of the alter- 
native budget balancing policies on key variables for the economy. Finally, on 
the bottom of the table we show for each quarter the policy adjustment whick 
was required to balance the budget. 

Balancing the budget in a period of deficit lowers real GNP and increases 
unemployment since budget balance during such a period implies increasing 
taxes or cutting expenditures. Naturally, the reverse will be true in a period 
where there would otherwise be a surplus, since in that case budget balance calls 
for tax cuts or expenditure increases. A critical question to which there is not 
always an a priori answer is the impact on inflation, considering the fact that 

(29) 



30 

inflation depends not only on demand pressure but also on cost considerations 
which may be greatly influenced by wage demands and productivity. 

By and Large the simulations with the model support the notions of real effects 

on output and employment noted above. The balanced budget policy simulation 
starting with 1965.3 reduces real GNP by s 1 1 billion by the last quarter of 1968 
when the personal income tax i- used as the budget balancing policy tool. The 
unemployment rate is 0.7 percent higher, 3.4 percent (base solution) to 4. 1 percent 

with the balanced budget. The activity level stays below the base solution in the 
fir-t half of 1969 even though taxes were decreased at that period to offset the base 
solution surplus. This tS because of lower levels of income and employment that 
existed throughout the three and a half years of the balanced budget simulation. 



31 



to ^-. 



— • o 



o *r 



— U3 



<£> —i 



I — vD 



— O 



ro ^j- 



— o 



u-> — < 



—I VD 



PO -H 



CSJ — < -^ 



= -^00.00 g-s- 9 

~! a. 00 



*2* o 

o t a> -_ ■•- ww 

■vuo w > <J o 

- "^ o c c c 

T3 ** o re — 



1 a> o 



o. re </>T3 

— * = ,„ 



' c re c 
1 .2 ° L J2 w 
I.SaS.2 re ro 

^itiis s#igi| JiSssi sf ts ® 

a; w ^ w — re 3 3 w — re— 3 

n u. J3 O ro 23 Q2 CO 00 ^ CO CD CO 

CO cc — 



5 w 5 

wE a,.. 

o >. o ^ 



. ..Q w 
0- </l ft> ^ 'wCw""5> 

M^ X Mm MS 9 ^ 



32 



r-> — CM 



mo lo 

OO oS CM* 

1 + + 



in r-» cm 

co ^r in' 

+ I I 



CO *T 



+ I 






CO IT) 

+ 7 



oo <r> "• 

uo r^ c\i 



+ I 



— ■ o 
r— r->. 

co co" 



IT) IT) 

co' co 



o o 
oo oo 

CO CO 



to CO CM 

— < ■— • CM 

+ I I 



I I 



CO IT) 00 

+ 7 7 



+ i 



oo oo 
co co' 



I + 



m io — i 

i-J »-J CM 

+ I I 



2 !'* 



co rs« ir» 

co co "O-* 

+ I I 



— Qfl E 



m ,s £ , * £ * ] - m§ ;^ i -O.J 

ro 's>o 'ojCoj,. 3 "° to !2 i 9 »/. 

— . = = = c <" e ;;_ <-> a> „, -o a> >< ". '^Mg 

>>oo^o .^t;^-g «S£ = «"§ = a, E as E <*> $ «" 
o w. M g, v> ' <u =: qj if o >- = ro J2 ooo oo^oo jg-o 

aS e m» S »f » »= § S »S « = g = » =r c 
E °; eg -a q.2 ^.£1=a.o<>S;£?:>.2.ojH.5j2 a. to u «, 

<U QQCQ GO CO «• O O O 



33 



in to 

.-tun 



— ■> IOU3 



LO OO 



r-» co •— '. 



+ 1 I 



I I 



I I 



CT> CM — « CVJ 



r-^ r^ r>» r^. 



to <£> 

cvico" 



torn 
od cm' 



+ 1 I 



OO CO 

oo «a- 



COCVJ to 

oo" cm" o 

cvjco ^r 

+ 1 I 



ui to m 



IDCO r^ 

coin csj 

CslCvl CO 

+ 1 I 



in is u <o 



in in in 



l-*0 *»• 



CMCVJ CO 
+ 1 I 



tDlO 

co'od 

+7 



> r- to t— i 



CM OsJ CM 






CO CO OO IT) 



M M N 



+ 1 I 



CO CO CO CM 



into oo 
1+ + 



CO CO CO CVJ 



COCO v— 

r>-"oo' ~1 



|S5 






'■gg, 



, R> C o 43 — i TO 

"° «"° ™ "--S !"° « 

a> c aj "2 <d </> cd 4] c 

bHi»0<l2-O o MX MO) 

■o E"° S>.~ S>-o,£— E" 

QQ 00 .Hcace. CD C 
o. 

E 



CO = .<-< -J - 



a, mx co a> 



.° 35 -o ro-a £ 



■*■' 3 
gQQOQ QQ 



1 <a 

IT3 I ' 



? 52 3 S<£-= 

[rS.g§2L§°_ 

i'Sg.JeeBg 

'4^ -Q cu a> aj — 

5 S) m g ™ ™ ™ S 

1 ^>.c O O O 



34 



0~> o~> o*> oo 



-~in wr> oo Nor^ 

lH iTJiri lO rvi fieri 

+ I I 



o m ~ <r> tsi 



r-^oi<X>0O l^^"f in 

so t£> r~ ro — . i/^ tD oo 

Psirsicsicvi a-i a-i a-i a-> 



I «o- cr> 07. rr> 

CC CO fifl CC 



— (£ 00 CSI 



omneo 

cow* 



«'in'io 

4- I I 






(M(NOC 



i 5 r-~ o 

O CT) «■ 



+ 1 I 



flifir^c 



»>«CO 
^•' trj lt> tr> 






ono 

IT) l£> O 

— •— CM 
+ I I 



r— lT> «»• 

oo'fNJoi 
csiroro 

+ 1 I 



*• — OCT) "* 


orvexc 
«a- o-> *r o-j 


•J- 00 to lT> 
in in in ^r 


u3 — * r^ 


y> odiri to o 
o~> O^ 0~> O^ 5 


co m en (vi 


in in in l£> 


ON« 

+77 



ami 

o >> o 

ere 

— Q. </> 

_ Q> 

a> H = 



Hi 0) (D w 4) 4i O q; 

' <J O O O uuo 

2cccc»-ccc:!z 
5 2i2J2JS St 2 JE J2 12 
:«■■•£'&•■« 
:3-Q-oJ3 re .2 .0.0 .a 

MMH 






oj o> > 



e c 






I 3 3 — re 3 3 3 

I CO QD _b CO CD CD CD 

E 



I « » r 

OC Q£._ oc 
JTS-O — 

1 3 3 0> 3. 
| CD CO 0«XJ< 



* = § 
o E„_ 
ere" 



c a> re 
o "S •= 

2 c y 

5j re 3 

E E E 
a> a> oj 



35 

Three years of adherence to a balanced budget policy during the recession 
period of 1969.3-1972.2 when base solution deficits were substantial worsens 
the income employment situation considerably. Ileal GNP is lower by $28.5 
billion, $27. S billion and $44.4 billion using respectively policy tools of personal 
income tax, transfer payments and government purchases of goods and service-. 
Compared to the base solution rate of 5.61 percent unemployment is 7.0 percent, 
6.7 percent and 9.6 percent after balancing the budget using the three tools 
respectively. At the same time, the inflation situation is not changed significantly 
with a balanced budget. 

The 1972-74 upswing generated fairly small deficits in the latter half of the 
period. Offsetting the deficits over this period reduces real GNP by $7 billion in 
the worst case of the three simulations by the end of the period. 

With regard to inflation, budget policy appears to have little impact in the 
model simulations. The econometric model solutions show little response of 
inflation rates to changes in budget policy; in fact in certain cases, the results 
may go in what may superficially appear to be the wrong direction. In some cases 
an increase in government spending, or a cut in taxes will actually tend to reduce 
the price level. This is a phenomenon which has often been noted in econometric 
simulations. It is not clear whether the response of price to cyclical changes in 
productivity, the source of this phenomenon, is quite as immediate in the real 
world as in the model. But it is clear that so long as budget policy is kept within 
reasonable limits, budget balance would not in itself greatly improve inflationary 
performance. This is not to say that during the 1960's a consistent policy of 
running surpluses might not have averted some of the inflation which occurred. 
We are saying only balancing the budget would not have greatly changed the 
situation. 

The large differences in the impact of alternative policies used to achieve 
budget balance should be noted. Changes in taxes or transfer payments have 
relatively small real impact, whereas changes in government purchases of goods 
and services with their associated direct implication for employment have the 
greatest impact. 1 Three years of cuts in government purchases of goods and 
services and corresponding cuts in employment in an effort to balance the budget 
during the recessionary period of 1969.3-1972.2 would have brought real GNP 
down by $44 billion in 1972.2, about $16 billion more than that simulated using 
the other two balancing instruments. 

Because of the higher multipliers and direct reduction in government employ- 
ment, the swings in the unemployment rate are much higher with the policy of 
adjusting government purchase to achieve budgetary balance. Unemployment 
rates as low as 2.4 percent and as high as 10.0 percent are generated. The corre- 
sponding upper and lower limits are 7.0 percent and 3.6 percent when taxes are 
used to balance the budget and 6.7 percent and 3.6 percent when the balancing 
instrument is transfer payments. The base solution unemployment rate during 
this period lies betw r een 3.3 percent and 6.0 percent. 

This study suggests that a continued policy of budget balance would have 
tended to destabilize the economy in terms of real output and unemployment, 
during most of the periods considered. The limited times of budgetary surpluses 
were also times when economic activity was near the economy's capacity and when 
budget surpluses were required. It would be inadvisable to balance the budget at 
such times. In turn deficits correspond in large part (but not during 1966 to 1968) 
to periods when unemployment was undesirably high. At these times balancing the 
budget clearly worsens economic performance. 

During 1966 to 1968, when a tax increase was clearly necessary, balancing the 
budget would have relieved some of the strains on labor markets, though perhaps 
too much so in 1967-68 if a policy of budget balance through cuts in purchases had 
been implemented. 

With regard to inflation, the results are not nearly so clear. The impact of budget 
balancing on inflation is extremely small at least over the periods considered here. 
There are counter-intuitive results; in some cases, reducing the deficit increases 
prices. These effects are small but appear to reflect the nature of the price deter- 
mination process and the definition of the price deflator. Prices involve elements 
from the cost side and from the productivity side. Reducing output frequently 
reduces productivity and that may cause upward pressure on prices even when 
output and employment are reduced. Moreover the definition of the price deflator, 
a current weighted price measure, sometimes means that mix changes will affect 
prices. A reasonable conclusion is only that over the periods observed balancing the 
budget would have had little price impact. — 

1 The least impact on activity level would, of course, be if the balancing tool was corporate taxes since it 
has little immediate feedback into the system. 

O 



UNIVERSITY OF FLORIDA 



3 1262 08718 2282